Outsourcing, once seen as a practice suited mainly to community banks, has become increasingly popular with the nation's largest institutions.

According to Computer Based Solutions Inc. of New Orleans, 26% of outsourcing contracts signed in 1994 were with financial institutions with more than $10 billion in assets. Only 6% of the contracts were with banks in that category in 1993.

Though numbers for 1995 and this year are not available, indications are that banks bigger than $10 billion in assets have continued to look to third parties for processing.

The fact that large banks outsource is not news. In the early 1990s, the mega-outsourcing deal became almost commonplace. First Fidelity Bancorp. signed a $450 million contract with Electronic Data Systems Corp. in 1990. In 1991, Continental Bank Corp. inked a $500 million deal with Integrated Systems Solutions Corp., International Business Machines Corp.'s outsourcing unit.

What is new, however, is that the outsourcing deals of the past few years have not typically covered entire core processing functions. Instead, the largest banks are picking specific applications to farm out - leading to a demand for outsourcing not seen for two decades.

"There's been a transformation in the philosophies of the typical chief information officer," said M. Arthur Gillis, president of Computer Based Solutions. He said that more tightly focused deals are becoming the norm.

However, the fact that huge core processing contracts are less common does not mean the mega-outsourcing deal is dead.

Just last month, IBM signed a $533 million contract to provide one of the nation's largest thrifts, Washington Mutual Inc., with a variety of strategic services, including desktop and network management.

Given the size of this deal, many experts were surprised that it did not include core processing.

But as mergers among banking companies create larger and larger banks, it stands to reason that even deals for very specific services will be big.

Experts said the mergermania among banks has other effects on the bank outsourcing business. For starters, mergers can significantly change existing deals.

Examples of this abound. First Union Corp. and BankAmerica Corp. both promptly revised outsourcing arrangements of their respective acquisitions, First Fidelity and Continental, upon merging. And Chase Manhattan Corp., which merged with Chemical Banking Corp., canceled altogether a check processing deal it had struck with Fiserv Inc.

The fact that banks continue their relationships with outsourcers indicates that they are mostly satisfied with the services, said industry experts.

"As banks focus more on reorienting their customer focus and product offerings, they're looking for ways to do things better and cheaper," said Richard Dole, a Houston-based partner at KPMG Peat Marwick.

"Outside companies provide the expertise for banks to reposition themselves to attract and retain customers."

All of this illustrates the change in attitude toward outsourcing that has occurred over the last several years. Industry observers said there is no mystery to why it is becoming more popular among large banks.

"Outsourcing brings new technology, product functionality, and economies of scale," said Lawrence A. Willis, systems outsourcing specialist with First Manhattan Consulting Group.

"It makes sense to purchase services externally" if they're not part of a bank's core competencies, he said.

Applications that are not part of a bank's expertise or that do not provide it with a competitive advantage are usually the ones farmed out to third-party providers.

This is a change from several years ago, when many banks outsourced all or most of their core processing operations.

Some of the more popular applications being farmed out are loan processing, check processing, and electronic transactions, according to Computer Based Solutions.

Niche outsourcing lets large banks keep in-house the applications that help differentiate them in the marketplace, experts said.

The approach at First Union Corp. has been to outsource individual applications to get help in developing products and bringing them to market more quickly, said Austin Adams, executive vice president and head of automation at the $131 billion-asset banking company.

But the services EDS now provides to the Charlotte, N.C.-based bank are not as wide-ranging as the data processing management work it did for First Fidelity.

"First Union has not chosen to outsource any major part of its processing capability because we believe we have a competitive advantage that comes from the singularity of our systems and other internal technologies," said Mr. Adams.

He added that regional banks increasingly outsource network and desktop services - including the installation and maintenance of personal computers.

First Manhattan's Mr. Willis said other major areas being outsourced by large banks include data warehousing, the installation of relational data bases, teller platform automation upgrades, and telecommunications infrastructure, which often involves the management of call centers.

Stephen R. Bova, president of the global financial division of Alltel Information Services Inc., said the Little Rock-based company is making more and more call-center deals with banks.

"This is an area of growth because technology is critical to delivering better information and a higher level of service," said Mr. Bova. "Outsourcers can do this more economically by spreading the cost of systems over multiple customers."

Computing problems associated with the year 2000 have created another niche outsourcing area. The problems stem from the fact that the computer code in many older systems cannot make sense of dates beyond Dec. 31, 1999.

As a result, many banking computer programs that rely on dates for calculations - those that calculate interest, for instance - would make errors.

Alltel, for one, has established a millennium management business unit aimed at helping banks tackle the problem.

"The predicted expense to the financial industry to fix the problem is huge," said Mr. Bova. "It's also very complex because banks have so many integrated systems."

M&I Data Services Inc. has a similar initiative under way.

Patrick Foy, president of the Marshall & Ilsley Corp. unit's outsourcing business group, said M&I may have an easier time dealing with the changes because its 500 customers all run on a single software program.

"When the changes are made, we'll only have to do it in one place, as opposed to other companies that may have several solutions," he said.

Thus, outsourcing continues to adapt to the financial industry landscape, and experts see no indications that demand for third-party services will slow over the next several years.

Banks, too, are adapting by initiating more of a joint-venture structure in their deals, as opposed to straight contractual arrangements, said First Manhattan's Mr. Willis.

"Joint ventures are more equity oriented, with providers taking a higher proportion of the risk," he said. "There's also a common economic incentive to fashion objectives good for both parties."

For outsourcing providers themselves, the key to survival within their own consolidating industry will be to offer a range of capabilities, said experts.

"The challenge for providers will be to be present with more answers and solutions, and to be responsive with a lot of different technologies, because banks want one source," said Mr. Gillis.

First Union's Mr. Adams added that, although there are fewer providers involved in handling core processing operations, there remains more than adequate competition so that banks won't be disadvantaged.

"There continues to be a multiplicity of providers for the growing niche outsourcing areas," he said. "It's still a buyer's market."

Ms. Tucker is a freelance writer based in Hazlet, N.J.

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