Advantages of outsourcing systems are evident at Provident.

BALTIMORE'S Provident Bankshares had its beginnings more than a century ago as a savings bank for merchant seamen. But it hasn't been all smooth sailing of late for the $1.7 billion-asset institution.

After converting to a commercial bank in 1987, Provident lost money three out of the next four years. "We had a very poor loan portfolio," Peter M. Martin, the bank's president and chief operating officer, said flatly.

Mr. Martin stepped into Provident's troubled waters upon joining the bank in 1990. A former executive vice president of operations at another Baltimore institution, Equitable Bancorp, Mr. Martin followed his boss, Carl W. Stearn, to Provident shortly after Equitable was acquired by MNC Financial Inc. Mr. Stearn is now Provident's chairman and chief executive.

The two men had their work cut out for them. Provident's balance sheet was hobbled by sour commercial real estate loans, a poorly underwritten indirect auto lending portfolio, and low-yielding mortgages.

After taking the reins, Provident's new management moved quickly to stanch the flow of red ink. A plan to construct a 47-story office tower on the bank's headquarters property in downtown Baltimore was immediately scrapped. Instead, Provident sold its existing headquarters building and leased it back from the new owners.

The bank rolled much of its relatively large investment portfolio into mortgage-backed securities, a move that later paid off handsomely. Provident's mortgage-backed portfolio grew from an average of $97 million in 1989 to $558 million by the end 1992, producing nearly $120 million in income between 1990 and 1992.

"We were able to take some [of those] profits to clean up the loan portfolio," said Mr. Martin. The bank also shrunk its lending base from $907 million in 1989 to $645 million in 1992. Accordingly, Provident's nonperforming and past due loans shrunk from a high of $32.6 million in 1990 to just $6.3 million by the end of the second quarter of this year.

Amid this general belt-tightening, Provident also decided to outsource its data processing operations late in 1990. After a one-time charge that year of $1.3 million related to the discontinuing of the operations, "Outsourcing saved us initially $1 million a year. Now it's more than that," Mr. Martin said.

"I'd say it's closer to $3 million now," said Russell Johnson, Provident's managing director of operations.

Mr. Johnson said the decision to outsource was driven by operational as well as financial concerns. "What we had inhouse was efficient, but it wasn't very flexible. We needed something that could be changed more rapidly."

Provident's size also was a concern. Its processing demands would tax the typical community bank software package. But the cost of a new, larger International Business Machines Corp. mainframe and updated software - designed and priced with banks much larger than Provident in mind - represented a significant expense. "That upgrade would have been millions of dollars. Then there are capacity-planning issues for years to come," noted Mr. Johnson.

After reviewing its options, Provident enlisted M&I Data Services Inc.. the data processing subsidiary of Marshall & Ilsley Corp., a Milwaukee bank holding company.

"The discussion started out as a joint venture with M&I, where we would be their East Coast processing center," said Mr. Johnson. The fact that Mr. Martin had considerable prior experience dealing with M&I influenced Provident's decision.

Provident held onto several aspects of its operations, including check processing, office automation, and telecommunications. It also maintained an overall feeling of control. "A lot of companies that outsource might say, |It's your problem now,' to whoever the outsourcer is," Mr. Martin said.

"We don't feel that way. We don't think that works," he added. "We do want to manage the data processing." As part of that process, Provident has developed quality-assurance guidelines for M&I to follow.

The bank also retained about 30 of its 50 data processing employees. the others either left or were terminated. Of those that remain, five serve as a liaison team between Provident and M&I, taking the place of systems project managers.

"It's almost an industrial engineering kind of function. It helps people understand how the process works, and make business cases for additional products and services," said Mr. Johnson.

The planned joint venture between Provident and M&I was abandoned in 1992, and the outsourcer moved Provident's operations to its data center in Milwaukee. The renegotiated contract saved Provident an additional $865,000.

"The benefits of keeping sour mainframe local are more psychological than real," Mr. Martin said.

While external processing fees associated with the contract jumped from $2.8 million in 1991 to $4.5 million the following year, they held steady through the first half of 1993, at $2.1 million.

Estimating cost savings associated with an outsourcing contract, said Mr. Martin, is not a simple matter. "That's easy to figure out initially," he said. "But I think there actually may be a tendency to underestimate those savings as time goes on, because you're not faced with having to upgrade a mainframe or systems."

Rather than per-transaction payments, Provident's contract with M&I calls for tiered pricing based on the number of accounts processed, along with an annual adjustment for inflation. Once a threshold of a certain number of accounts is crossed, the pricing jumps to the next level.

Based on anticipated volumes. Mr. Johnson said, he expects Provident's unit-processing costs to remain stable for at least the next two years. "If the volume increases further, we'll actually be paying less per account than we are today," he explained.

After its string of bad years, which saw its dividend cut by more than half, Provident has returned to stable, if less than spectacular, profitability. Net income for the first six months of 1993 totaled $3.5 million, or $0.54 a share.

Now that most of its short-term problems have been addressed, Provident management has turned the loan spigot back on. Over the past year, it has acquired a number of consumer loan portfolios from third parties and developed nonbank mortgage and consumer finance subsidiaries.

By the end of the second quarter of this year, Provident's loan total had jumped to $917 million. "We're lending very well in commercial real estate, particularly in residential construction," Mr. Martin explained.

Still, Provident has focused primarily on the retail sector. "We redesigned our home equity product because we had the worst product in the market," said Mr. Martin. "Our amortization was over eight years, where most of the others were over 13. So we were disqualifying potential borrowers because they couldn't afford the payments. Now we have the least-expensive product."

Added Mr. Johnson, "We were able to develop that product in a couple of months. It would have taken at least six months with our old system, because we would've had to hard-code everything. Now we go in and design what we want."

The restructuring of its consumer checking accounts, and the subsequent addition of two demand-deposit products developed with Littlewood, Shain & Co., Exton, Pa., have also boosted business significantly. Mr. Martin said the number of checking accounts at Provident has grown by more than 60% since the program - called Preferred Checking - was introduced in February.

The new products "helped acquire a lot of checking account volume with less loss of existing customers," Mr. Martin explained.

Handling the increased volume was not a problem, according to Mr. Johnson, who developed the bank's check processing operations when he joined Provident 10 years ago, said, "Those operations were installed under the pretext that we were going to grow by leaps and bounds. Until recently, we never came close to that. Now we're starting to use our capacity on the check processing equipment."

Along with the new products, Provident has introduced branch automation as well. "The branches were literally using rubber stamps," Mr. Martin said. "Nothing was online."

The bank is in the process of rolling out a platform system based on M&I's Sales Partner software. "We have taken that and developed it for our needs," Mr. Johnson explained. "It was fairly generic and didn't have a lot of features. They've used us to help to develop that product."

In its redesign of Sales Partner, Provident has emphasized the product's sales function. That was an area where management felt other platform tools - as well as the original version of Sales Partner - were lacking.

"Sales Partner is for sales. It's to have a quality session with the customer. It's not to get them in and out of the door as quick as we can," Mr. Johnson explained.

That emphasis extended to something as simple as screen savers. Working with the marketing department, the development team created "slide shows," consisting of 10-slide presentations for each product line. "I don't think anybody working for M&I or with Sales Partner has developed that to the extent we have. The products basically sell themselves," said Stacey Davidson, a platform automation specialist at the bank. She noted that one of the slide shows convinced a customer who was waiting in the lobby to take out a $70,000 home equity loan.

"This system gives us a consistency and a professionalism from branch to branch that we didn't have before," said Mr. Johnson.

However, the system does need some tweaking. The platform workstations, which are PCs, interface to host via the IBM 4700 configuration of the teller terminals - a situation that Mr. Johnson says creates some performance problems. An upgrade to a PC network scheme is on tap.

Also, because the system focuses on selling, using it to open an account can be time consuming. For that reason, checking accounts were often opened manually during Provident's recent boom.

"Our programs were working so well that at times we had customer lines out the door," said Mr. Johnson. A system upgrade, he added, will streamline the process.

Still, that's a problem many banks would like to have. How long Provident will continue to be faced with such issues, however, is another question. The bank has been frequently cited as an attractive takeover target. A recent mention in the "Inside Wall Street" column of Business Week drove Provident's stock to a 52-week high of close to $20 a share. That is the first time the stock has traded at its book value in recent memory.

Mr. Martin, as might be expected, discounts the acquisition rumors as part of the ongoing consolidation within the industry. "We run the bank as if we if were going to be here forever," he said. "On the other hand, we also run the bank for our shareholders. So if somebody came along with what looked like a good offer, we'd have to consider it."

Quite a change in fortune for a bank that for a while appeared to be a sinking ship.

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