Banks, especially small ones, that have yet to invest in check imaging technology are increasingly likely to outsource the work rather than license software to use in-house.
Industry watchers say that the financial companies still lacking imaging capabilities are being squeezed by two trends. First, as the use of image exchange networks grows, the economic incentives to adopt the technology become more pressing. However, as consumers write fewer checks, the volumes moving across the image exchange networks are getting close to their peak, making these investments less appealing and outsourcing more appealing.
Brian C. Hurdis, a senior executive vice president and the president of Metavante Technologies Inc.'s image solutions unit, said the demand for imaging software has shifted, and banks are now asking more for outsourced services. "That business has fundamentally changed. People want to pay as they go," he said.
One sign of this shift came last week, when Metavante announced it had taken a writedown of nearly $130 million in the fourth quarter because of slower sales of imaging software in the second half of 2007. The results were such a surprise that the Milwaukee vendor did a review of its imaging unit and concluded that the sales outlook for 2008, though better than last year, is now expected to fall short of its previous projections because of slowing demand for imaging licenses.
Though many banks still do not have imaging capabilities, most of the big ones installed the technology years ago, and the holdouts now tend be small and midsize financial companies.
Cary Whaley, the associate director of payments policy at the Independent Community Bankers of America, said outsourcing can be especially attractive to smaller banks, because signing up with a third-party provider immediately brings a network of other banks with which they can exchange images. "The term image exchange implies other partners," he said. "That's where an outsourcer can be helpful or a correspondent can be helpful."
Other vendors have noticed a spike in demand for outsourcing from smaller banks.
"At the low end of the market especially, a lot of small institutions prefer the 'rent' way rather than the 'buy' way," said Vijay Balakrishnan, the chief operating officer of VSoft Corp.
VSoft, which provides software for regional and community banks, is fortifying its servicing capability in response to growing demand for hosted image processing. The Atlanta company recently purchased a Davenport, Iowa, service bureau, Branch21 Inc., which already offers VSoft's image processing and other software to 50 financial institutions through three data centers, Mr. Balakrishnan said.
VSoft plans to announce the acquisition Monday.
VSoft is finding that the biggest demand for outsourced image processing is from institutions with assets of less than $300 million, Mr. Balakrishnan said. "As you go up in size, there is a need for more control," he said. Bigger banks "want more customization."
Stacey Zengel, the general manager of Jack Henry & Associates Inc.'s image solutions unit, said that about 60% of its 2,400 bank and credit union clients have adopted imaging, with the numbers split about equally between those using the software in-house and those outsourcing.
However, as the vendor's remaining clients implement imaging, he expects the mix to change. "I think we'll see a trend toward outsourcing over the next two or three years," he said, with virtually full adoption of image exchange by the end of 2009.
Mr. Whaley said that in the past year, imaging has become a more pressing concern for banks that still lack it.
In a survey it released in early 2007, the ICBA found 42% of its respondents were active in image exchange and 45% more planned to become active within two years, Mr. Whaley said.
But that was before the Federal Reserve banks announced plans last June to accelerate the ongoing consolidation of their check processing network, Mr. Whaley said. "Now banks that are adopting image are seeing an economic case for it."
But as image exchange becomes ubiquitous, observers are predicting that the volume of checks sent across these networks will eventually peak, because the total number of checks written is falling. And those competing trends are making outsourcing even more appealing.
Stephen J. Ward, an executive vice president in Fiserv Inc.'s financial institutions group, said outsourcing will increasingly gain favor once image exchange volumes begin to decline.
"The capital investment required is always a factor," Mr. Ward said. "Outsourcing becomes a variable cost model. As their volumes go down, their bills go down."
Fiserv, of Brookfield, Wis., has long had a strategy of using its position as the nation's largest non-bank check processor to capture additional outsourced business as check volumes decline.
Aaron McPherson, the research manager of payments at the Financial Insights Inc. unit of International Data Group Inc., predicted that the surging growth of image exchange would begin to flatten out this year and that image exchange volumes would begin to decline in 2009.
He acknowledged that some other observers believe that growth will continue into next year or even 2010, but "either way, the decline is coming. They're just running out of checks to image."
In its triennial payment study released in December, the Federal Reserve banks reported that American consumers and businesses wrote 33.1 billion checks in 2006, declining at a 4.1% annual rate from its previous study, covering 2003. The number of checks paid fell even faster — at a 6.4% annual rate, to 30.6 billion items — because more checks are being converted to automated clearing account transactions.
At the same time, image exchange continues to accelerate. The Electronic Check Clearing House Organization, the rulemaker for image exchange, reported that as of November, the latest figures available, the financial system was handling images at an annualized run rate of 9 billion per year.
That month 750.1 million items cleared as image, triple the level of a year earlier, the Dallas organization reported. David Walker, Eccho's president, said image exchange volumes probably will not peak until next year. "If that happens we will be extra successful in converting checks to images," he said.
