COMMUNITY BANK in Ohio expects a new check image processing system to bring in new accounts, cut operational costs, and prove to customers that the bank is at me forefront of technology.

The First-Knox National Bank of Mount Vernon, a $414 million asset bank based in a central Ohio town of 16,000, is among a growing group of smaller banks to offer socalled check image statements, whereby canceled checks and deposit slips are scanned into a computer and then laser printed onto monthly account reports.

"Our customers expect to see the benefits of technology," said Carlos E. Walkins, president and chief executive. "Though a lot of banks are imaging, it' s not getting to the customers."

A growing number of large banks use imaging in their operations to help move the mountains of checks that pass through back offices, but customers never see it, he explained.

Working through AT & T, which has a facilities management contract with First-Knox, the small bank shelled out $750,000 to get NCR imaging equipment and Document Solutions Inc. software up and running. Savings in postage and streamlined operations will recoup that investment in a few years, Mr. Watkins said.

The bunk expects to be able to shift five employees to other tasks while also signing on new accounts.

Customers first learned about the new service when they opened August statements. In addition to the usual canceled checks, they received the images of the checks, twelve to a page. Customers also received a notice that from that time forward, they would only receive the check images.

Other banks that have rolled out image statements told First- Knox that explaining the service beforehand proved confusing to customers. It created a wall of resistance that was difficult to overcome. Not giving customers advance notice may have cut down the number of complaints but some customers haven't warmed to the system.

"We are finding a group of customers who are reluctant to change," he said.

Of the first 5,000 customers to receive the new statements, fewer than five have canceled their accounts and just about a dozen have opted to continue having their checks returned, said Ian Watson, vice president of operations.

In contrast, 140 of Unity Bank and Trust Co.'s 10,000 customers asked to have their checks returned when the $145 million-asset bank rolled out check imaging in March 1993.

The Rocky Mount, N.C., bank, which alerted customers to the change before sending out image statements, was pleased by the high acceptance rate.

There are two schools of thought in how to explain check imaging to customers, said Richard Crone, a consultant with KPMG Peat Marwick in Los Angeles. He said that telling customers in advance is like putting ice cubes in a pot to gently warm them, while just sending out the new statements without prior warning is like taking a hammer to the cubes to break them up.

Mr. Crone admitted, however, that not issuing an advance warning seemed to work in FirstKnox's case. With so few defections, "it looks like they were able to pick up the pieces without losing many," said Mr. Crone.

Not everyone thinks community banks should venture into the check image statement arena. Mr. Crone, and other consultants, say banks should think hard before dropping a half-million dollars for new check processing systems..

He said customers look at check processing more as a pass-fail item rather than one graded on an A through F system. Consequently, giving customers check image statements that don't contain any more information than customers would have received previously doesn't build on the banking relationship, he said.

"Check processing is not viewed as a valueadded service," he said.

But Mr. Crone noted that many community banks are facing decisions about their check processing systems. According to a recent Peat Marwick survey, he said, 85% of the banks that do their own check processing have systems that are more than five years old.

"That's like riding an American car with 200,000 miles on it," he said.

Mr. Crone's advice? "Try to squeak by as long as you can.

"Remember when people bought screen typewriters because they showed six lines? Who uses them now?" he asked.

"Everyone has computers," he answered.

"Why bet on image? Why incur the risk?"

First-Knox is telling its customers that the imaged statements are a value-added service. In that campaign, it has the assistance of the customers' accountants, who like the consolidated statements because they are organized by check number.

Previously, when a customer came to the bank asking about a check, it would take as long as a half-day to overcome the backlog of requests and the difficulties of using microfilm, Mr. Watson said. With the imaging statements, a customer can have a cup of coffee during the few minutes it takes to locate an item, he said.

To help customers, the bank has printed the statements on paper punched for a three-ring notebook. That, combined with a complimentary binder, has been a large expense. But, as a sales tool, it is worth the effort, Mr. Watson said.

Despite its perception that imaged statements are a service improvement, First-Knox won't charge more for the imaging service. It will, however, levy a $3 monthly charge to return checks, since that is a more costly operational difficulty for the bank.

In the few weeks the program has been running, First-Knox hasn't had many difficulties, Mr. Watson said. One problem that customers are being alerted to is that checks written in red ink will not photograph.

Another problem came from a few brands of mail-order checks. While about 98% of customers choose the Deluxe checks that the bank sells directly, about 2% buy checks elsewhere. A few of the non-Deluxe checks have backgrounds that defy imaging, Mr. Watson said. Those few customers have been notified, he said.

Mr. Watkins believes check imaging will fit the bank's strategy well. It will demonstrate to customers that the bank can meet their needs through cutting-edge technology.

A few customers had observed how nice American Express' imaging of credit card transactions was, Mr. Watkins said. Now customers can see that the bank is serving their needs similarly, he said.

To maintain earnings growth, the bank has set its sights on building its "specialty" businesses in an attempt to relieve a dependence on revenue from one or two dominant areas.

That's in part because First Tennessee regards its core retail bank as a mature business. "We believe that over the next several years we are going to have a relative slow-growth economy, a nominal growth rate," said Mr. Horn. "So you've got some constraints on the amount of growth you can expect in earning just from a retail/commercial banking franchise."

The bank, he said, will continue to emphasize its bond division, which buys and sells fixed-income securities and provides securitization and advisory services to more than 2,000 other banks.

"Bonds has been seen by the outside world as being the biggest number out there," said Mr. Horn, who rose through the ranks of that division.

And to spread its wings, First Tennessee acquired in the last year two mortgage banking companies, Maryland National Mortgage Corp. and Sunbelt National Mortgage Co.

'If you look at the growth rates in that business they are much higher than retail/commercial banking prospects going forward," said Mr. Horn.

He added that the bank is also looking to make a third major acquisition of a mortgage banking company, perhaps later this year. "That will put us in the mortgage banking business at a level that will allow us to compete with anybody in term of product, price, and economies of scale," Mr. Horn said.

"What we wanted to do is build a mortgage banking business that would be complementary to the revenues that are produced by the bond division" and other business lines.

Mr. Horn said the goal is to boost revenue from those niche services, which include credit card and trust, from 50% today to 60%.

Ms. Lister called that "an admirable goal."

While the bank moves to grow bond, mortgage, and other lines, Mr. Horn noted that First Tennessee already has a strong retail bank with 225 branch offices in the state's major markets.

Still, retail is an area where bankers are looking to gain efficiencies. Mr. Horn said the company is now undergoing a "benchmarking" process to see how it stacks up against competitors.

"It' s not a reengineering. We don't use that buzzword," said Mr. Horn. "To me that is a term for layoffs, or changing the size of your work force ."

"We don't focus on cutting people as much as we focus on making sure that they are maximized," Mr. Kelley added.

Mr. Kelley also said there is no need for a large-scale reengineering. "We began in the early 1980s pressing for standardization and centralization of back-office systems. I think we were very early in that process," he said.

The bank, for example, operates only one software application for each product.

As First Tennessee undergoes the benchmarking process, it is not gauging its success by looking at an efficiency ratio for the entire bank. "We don't focus on and talk about an overall efficiency ratio number anymore," said Mr. Horn. He noted that while some of the businesses First Tennessee is in -- notably bonds and mortgages -- are big revenue producers, the return on revenue is lower than traditional banking, which skews the ratio.

Mr. Kelley estimated that the efficiency ratio for the retail business is 61% or 62%, about average for a regional bank.

Ms. Lister agreed that a bankwide efficiency ratio is not a good measure for the bank. "It's unfair to say that First Tennessee is an inefficient bank. It more reflects the mix of businesses they are in," she said. She agreed that the large bond operation makes the ratio appear "artificially high."

Ms. Lister added that the success of the bond unit has also overshadowed the check clearing operation, which does business in 43 states. The service, called First Express, is the fifth largest bank check clearing operation in the country, officials said.

Mr. Horn said the service began in 1980 because of Federal Express, the overnight courier headquartered in Memphis.

"Through their system we have more one-day presentment points for check clearing than anybody in the country," said Mr. Horn.

First Tennessee rents space from Federal Express near the city's airport. "We have agreements with them, for example, that the bag of checks that comes in from any collection point will be be first thing that comes off the plane at night," said Mr. Horn. "And they are the last thing that goes back on the planes before they leave."

The number of transactions handled by First Express has grown at an annual rate of 21% for the past three years. In 1993, the bank cleared 293 million checks.

"We are sending checks to almost 200 end points nationwide. And we are collecting checks from about 120 customers nationwide," said Mr. Kelley.

First Tennessee has also built up a separate business -- merchant processing -- around another Tennessee company. "We got into that business because Holiday Inn was located here," said Mr. Horn, referring to the motel chain that has since moved its headquarters from Memphis. "But we used that as a basis then to be able to expand and be able to offer those services to a lot of different merchants all over the country."

First Tennessee, which supports about 13,000 point of sale terminals, is the sixth largest bank merchant processor in the country. Transaction volume has been growing at 16% a year since 1990.

Mr. Kelley said that technology plays an important part in all of First Tennessee's businesses. "I think the utilization of technology in the bank is probably going to have as much to do as anything in helping to improve our efficiency while improving our level of service also," he said.

First Tennessee, for example, began to offer consumers check image statements in 1992. About 50% of its existing customers receive the check images, Mr. Kelley said, along with 90% of new accounts.

"We were able to save as much as $200,000 with a combination of processing costs and postage," he said.

Mr. Kelley said the bank's relationship with IBM led it to offer check imaging earlier than it otherwise would have. For 14 years, the bank was a partner with IBM in a software company called Check Solutions.

The link between First Tennessee and IBM is strong. In the 1980s, the bank, which had long been an IBM shop, considered outsourcing its data processing. After contacting six outsourcers, the bank chose Big Blue.

That decision was made after management observed that the largest banks in the country were spending more and more to develop technology, said Mr. Kelley. "For us to compete with... the large banks and the nonbanks -- we felt we needed a technology parmer."

The computer operations were outsourced under a 10-year, fixedcost contract. IBM runs the bank's data center. It also maintains nearly all of the bank's hardware and software, including more than 3,500 personal computers.

IBM "also provides [and maintams] the digital [communications] switches at the necessary locations,"' he added.

"I think we were pretty early in the game of looking to outsourcing," said Mr. Kelley. Prior to 1989, the bank had already outsourced the mortgage processing system.

First Tennessee has also looked outside for student loan, merchant, and credit card processing.

Mr. Kelley said the bank has been very pleased with its arrangement with IBM. He noted that since 1989, the bank has bought two $800 million-asset banks, two smaller community banks, two mortgage companies, and an investment bank without "incurring a single dollar of additional expense in systems."

"We are at the maximum of the transaction and account capacity that we had under that contract," he added.

As Mr. Horn looks to implement the long-term strategic plan, he may have to deal with First Tennessee becoming a takeover target.

Mr. Coffey of J .C. Bradford has said he expects Memphis to be a feast for acquisition-hungry banks. Noting that First Tennessee is the largest bank in that market, he said, "It's the bank that everyone will look at first."

Mr. Horn shrugs off the takeover speculation.

Instead, he's focusing on building mortgage banking and other lines of business. He said he will keep an eye out for possible bank acquisitions, but high prices may keep the bank from buying.

"Our strategy is not to grow by acquiring," he said. "Once you start acquiring -- if that's the way you're getting your growth- you get in a game where you have to continue to do that or your growth is going to slow down."

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