Two months ago, Huntington Bancshares won long-sought approval from the Federal Reserve to start a nationwide check clearing network. Now the question is: Can it put off the ambitious plan?
The Ohio-based company and two partners aim to persuade a number of large banks to join together to clear checks, bypassing the Fed's extensive system and their own private arrangements.
The lure: a promise of annual cost savings ranging from $100,000 to $1 million.
Many in the industry wish Hungting luck, if only because its plan would provide competition in the Fed-dominated check-clearing arena.
Last year the Fed raised his processing fees by an average of 3%, including a hefty 16% increase in check transportation charges. Those hikes "caused people to start thinking about other ways to handle checks," said Gerald Milano, president of the California Bankers Clearing House Association.
Key Challenges
But Huntington's road won't be easy, industry players said. Among the key hurdles:
* The company must sigh up enough banks to create adequate volume.
* It must demonstrate that it can process checks more cheaply, while at least matching the service provided by the Fed or private clearing arrangements.
* And it must effectively deal with technical aspects of settlement.
"Anytime you set yourself to compete directly with Fed services, you've cut out a tough road," said one clearing house official who asked not to be named.
Robert Fitzgerald, president of the Chicago Clearing House Corp., added: "The check collection business is not solely driven on price and transportation. Availability, timing, and relationships between banks are also important."
Six Billion Checks a Year
The Hungtington venture is targeting a slice of the estimated six billion checks a year that need to be transported between banks in different federal Reserve processing districts.
A bank currently has relatively few options for processing these items. It can send them to the Federal Reserve or a correspondent bank, which will sort and distribute them for a fee.
Or it can sort the checks itself according to recipient band and then deliver them either directly to each bank at prearranged times or to each bank's local clearing house.
The Huntington effort - known as Chexs, for Check Exchange System - aims to cherrypick some of this interdistrict volume. Because its system won't have to be as extensive as the Fed's, Huntington thinks it can underprice its rival.
One of its partners, US Checks, will provide transportation via its fleet of jets - which already carry many items for the Fed. The other partner, Littlewood Shain & Co., will market the service and provide consulting.
Actively Recruiting
A bank using the network would sort checks going to other Chexs members by city. It would send all the checks destined for each city to Chexs, which would present them to the check writers' banks, thereby bypassing the Fed and its presentment fees.
So far, 10 banks have agreed to join the clearing house, and the partners are actively seeking more members, according to John Shain, president of littlewood Shain.
Mr. Shain declined to name them, but another source close to the projects said they include units of Barnett Banks Inc., Boatmen's Banchares, First Chicago Corp., First Maryland Bancorp., First Security Corp. in Salt Lake City, and Fleet Financial Group.
Five of the members will start testing the network next month.
Chexs sees its potential market as one billion to two billion interdistrict checks a year, and believes it can actually get 500 million to 800 million of them, according to Mr. Shain.
Chexs expects to have gross revenues of $2.5 million to $4 million a year.
Over $1 Million Invested
Rick Sellers, president of Huntington Automation Co., a unit overseeing the effort, declined to project the venture's profits. He said Huntington, which is the majorty owner, and its partners have already invested over $1 million in legal costs, hardware and software, and other start-up expenses.
Mr. Sellers said Huntington hopes the service will be the first step in building a fee-income business similar to those to Mellon Bank Corp. and Wachovia Corp.
"The service company today is not a fee-income producer, but going forward that is one of our strategic directions," he said.
Will Chexs be able to attract enough banks?
Hungtington said it has talked to about 70 large clearing banks, and that many are seriously interested.
Growing Banks Sought
The largests, at least initially are rapidly expanding banks with facilities in multiple cities.
Mr. Sellers contends that with as few as five to 10 banks, the venture would be economically viable.
By the start of 1993, Hungtington expects to have about 40 participants, at which point volume should mushroom.
The selling point will be cost savings. Before volume discounts, for each item as Chexs participant would pay 0.5 cent to the partnership for operating the net settlement function and 0.7 cent to the receiving bank for processing and distributing it to the local clearing house.
In most cases the Fed Charges more. Fed fees range from 1 * 1 cents to 2.9 cents per item.
Chexs could also be cheaper than many reciprocal arrangements - known as direct sends - between large banks, he said.
Net-Settlement Plan
The thorniest issue in offering a check clearing service is settlement, or how banks pay each other. When Huntington first proposed the idea 3 1/2 years ago, the Fed raised a host of concerns.
The Chexs system will use a net-settlement arrangement, under which each bank makes or receives one payment a day from each other participant. The exchanges will be made through an account at the Fed.
Chex is insisting that members have more than $200 million in equity capital, limiting membership to the top 150 banks, according to Mr. Shain.
"We will modify that over time as we prove to ourselves and to the Fed that operational integrity is there," Mr. Shain said.
Bankers will have to evaluate the impact of net settlement, which will probably change when check transactions are credited to or debited from their accounts.
Bank relationship vary, and the way they received payment for checks presented also varies greatly. If two banks clear checks directly, they maintain balances with each other and periodically draw down from those accounts.
In a multilateral clearing arrangement, banks would not have to maintain balances. Huntington as the clearing agent would calculate the net position reflecting each bank's activities.
Under current funding arrangements, the Fed credits or debits for the net of a bank's check clearing transactions. The Fed credits at the opening of business, but charges debits at the end of the day.
Under net settlement rules, the banks in a net debit position will not be charged at the end of the day, but between 12:30 p.m. and 1 p.m. Eastern time. Creditor banks will get credits between 1:30 p.m. to 2 p.m.
Risk of Overdrafts
That could leave some banks with overdraft positions. "There are trade-offs," said Florence Young, a Federal Reserve Board aide who helped evaluated the Chexs plan. "Each bank has to see how it will affect them."
Some observers warned that while the Fed has granted permission for Hungtington to do net setllement, other issues still need to be ironed out.
For example, as the Depository Trust Co. moves toward same-day settlement, it is being required to have full backup for its computers and to institute limits on how far users can go into deficit against the system.
"Our experience has shown that successfully [implementing] negotiating net settlement arrangements through the Federal Reserve is very difficult and time-consuming," said John F. Lee, president of the New York Clearing House Association.
