ACH Shakeout: Two Players Retrenching

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Visa U.S.A. is quitting the automated clearing house processing business, after a string of price cuts from the Federal Reserve Board's market-dominant service apparently left it unable - or unwilling - to compete.

Visa's exit, to be complete in March, will leave only one private ACH processor in the market, Electronic Payments Network. The New York-based company, once a regional processor, only got into the business on a national scale in 1999 but now claims 30% of the market, with FedACH handling nearly all of the rest.

In a separate payments system development, Nacha, the electronic payments association, confirmed Monday that it had indefinitely shelved Project Action, a system it had hoped to build that would connect Internet shoppers and bill payers directly to their banks' Web sites, where they could pay by ACH direct debit. Though Nacha had set a late-February deadline for financial institutions to make financial commitments, the group apparently found out sooner than expected that banks were not enthusiastic about the project, which faced opposition from credit card firms.

"The board has instructed the Nacha staff to place the proof-of-concept on hold until such time as market conditions warrant moving forward," Nacha said in a statement.

Nacha sets the rules that govern the operation of the automated clearing house system, though it is not a processor itself. Visa, which has been in the ACH processing business for 15 years, has been telling its customers over the last few months that they will need to find a new provider, but has not made a public announcement.

In a statement, Visa said that its decision to exit the business came "after evaluating the current marketplace and our members' needs."

The statement said: "The ACH marketplace has changed significantly since Visa emerged as a private sector ACH operator in 1987. By encouraging competition, Visa played a role in improving the ACH network and reducing processing costs. Visa will be working to ensure a smooth transition from the service."

Visa's ACH customers include Zions Bancorp, First National Bank of Omaha, Huntington Bancshares Inc., and some large credit unions, among others, said George Thomas, the president and chief executive officer of Electronic Payments Network, which is a subsidiary of the Small Value Payments Co., which itself operates under the auspices of the New York Clearing House Association.

Mr. Thomas said that VisaNet ACH Services, which has just under 4% market share, has been encouraging customers to switch to his company, which he said charges less than the Fed. The Fed has been cutting prices repeatedly, particularly in the two years since EPN has gone national - which is a boon to the banks that pay the fees but has taken a natural toll on the competing processors.

"We're looking at ways that we can work together to transition as many of their customers over, and keep them in the private sector," Mr. Thomas said. "We have been able to get their larger customers to have us come in and talk to them," though not one has signed a new contract yet.

A third private operator, the American Clearing House Association, which had only 2.8% market share when it closed, said in April that it was going out of business because of the Fed's two price cuts over the previous six months. Electronic Payment Network picked up about 20 of American Clearing House's customers - most of the bigger ones, Mr. Thomas said. FedACH got the others.

In 1999, the New York Clearing House changed the name of its processing business to Electronic Payments Network and broadened it from a regional to a national scope. The following year, Electronics Payment Network LLC was incorporated by 19 major banks.

Though the thinning of the market has worked to Electronic Payments Network's advantage, Mr. Thomas is not celebrating. "I'm not happy that Visa is leaving or that the American Clearing House left," he said. "It's good that there's a private-sector competitor to the Fed."

When asked to comment on the Visa development and its role in the ACH market, the Fed said in a statement: "The ACH business is a critical component of the financial services industry and an important component of electronic payments. We see 15% to 20% year-over-year growth in ACH."

Mr. Thomas said that FedACH has lowered fees for ACH originations 44% since October of 2001, to $0.0025 per transaction from $0.004. In 1996, the fee was $0.007 cents per transaction.

For ACH recipients, the Fed charges $0.0025 per transaction, versus $0.005 in late 2001 and $0.009 in 1997, Mr. Thomas said. There is also a category of addenda fees that have been lowered.

Mr. Thomas said that Electronic Payments Network has lowered its fees in response. He said that the Fed has been charging slightly less on the receiving side, but that EPN will match its price come Jan. 1. His company, he said, does not charge the addenda fees, which include monthly fees per routing number.

"We don't want to get into a price war with the Fed," Mr. Thomas said. "They obviously have much deeper pockets than we do."

He said that his company is trying to market the advantages of its value-added services, such as Universal Payment Identification Codes, which are bank account identifiers that allow companies to receive electronic credit payments without divulging sensitive information. Mr. Thomas said that the Fed still relies heavily on a DOS-based system, whereas his company uses a more modern Windows-based system.

This quarter Electronic Payments Network introduced a service it hopes will distinguish the company: an early-warning fraud-alert system for transactions that fall under the new ACH classifications WEB and TEL, plus the older PPD category. The company has begun tracking all ACH returns with reason codes, and says that it will analyze these returns to look for suspicious transactions that might be fraudulent.

Steve Ledford, the president of Global Concepts Inc., a payment systems consultancy in Atlanta that has done considerable work analyzing ACH volumes, said that Visa's departure from ACH processing did not come as a tremendous surprise.

"The business for ACH processing can only support a limited number of players, and EPN has made a concerted effort over the last few years to be highly competitive with the Federal Reserve," he said. Not only has Electronic Payments Network built "a highly capable, high-volume platform," but it has also been able to take advantage of the banks that are customers and board members of its parent, SVPCo.

"There is also the fact that the banking industry is gravitating toward a few major providers of the utility services in the payment system," Mr. Ledford said. "I think that there are a lot of financial institutions who want to make sure that there remains a viable competitor to the Federal Reserve, just so that they can reap the benefits of competition in terms of price and service."

The fact that prices have been coming down for both originating banks and recipient banks has helped fueled the rapid growth of ACH transactions, which are growing for many other reasons, too, Mr. Ledford said. His company on Monday released the results of an annual payments study that found that 31 large institutions account for 51% of national ACH origination volume, 71% of national offline debit volume, and 63% of national online debit volume. The same institutions account for only 37% of U.S. payor-bank check volume.

"There has been a tremendous amount of reduction in the past 10 years in the cost of processing ACH, which makes it more difficult for the market to support a handful of competitors," Mr. Ledford said.

Meanwhile, the shelving of Nacha's Project Action seems to signal the traction that card payments have gained on the Internet. The project, approved by Nacha's board in late September after a proof-of-concept phase, aimed to raise $1.2 million from at least six banks so that it could build an ACH-based Internet payments system.

Nacha said in a statement: "Although many financial institutions and their customers support the Action concept and believe it benefits stakeholders in the payment system, the [Nacha board of directors] now believes that, due to the current business investment climate, Action will not receive the investment necessary to proceed at this time."

Nacha said that it "looks forward to continuing the project when market conditions allow."

Leonard J. Heckwolf, senior vice president of Bank One Corp.'s consumer payments solutions group and the incoming chairman of Nacha, spoke in a telephone interview last week about Project Action, praising "the design and the work that's gone on in Nacha to get that where it is," and calling it "a great example of what you can do quickly to assess a capability." But he added: "The question is, Is there a market need there - will the industry see a market niche?"

Mr. Heckwolf, who will assume the chairmanship of Nacha in January, recently headed the organization's "next generation" task force, which looked at potential needs of the ACH's infrastructure. The network now handles about seven or eight billion transactions a year, he said, and new transaction codes - such as ARC, the accounts-receivable conversion category - are among the factors expected to lift those numbers.

His committee looked at what might arise when the network has to handle, say, 20 billion transactions a year. "What are the product issues, the risk issues, to allowing this network to be robust at two to three times it is today," Mr. Heckwolf said.

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