Though many community banks outsource their merchant-acquiring operations to larger banks, more and more are contracting with third-party specialists, and a horse race seems to be shaping up between the two leaders.
The challenger is TransFirst Holdings Inc. of Dallas, which mostly processes merchant credit and debit card transactions for community banks that do not see a business case for doing it themselves.
Seven-year-old TransFirst is an emerging rival to ICBA Bancard Inc. of Arlington, Va., the payment services subsidiary of the Independent Community Bankers of America. The trade group set up the for-profit operation in the mid-1980s.
Though ICBA Bancard is larger, TransFirst made some major gains in 2002, thanks largely to a $135 million equity investment from its owner, the Chicago investment firm GTCR Golder Rauner LLC. (The firm also owns Verifone Inc., the payment terminal manufacturer.)
In October, TransFirst used the capital to make its biggest deal of the year. It bought the agent bank portion of the merchant-acquiring portfolio of BA Merchant Services Inc., the acquiring and processing arm of Bank of America Corp. BA Merchant Services was one of the largest companies in both businesses.
Earlier in the year TransFirst made two smaller purchases in the acquiring industry, buying Money Tree Services and DPI Merchant Services. TransFirst said the three deals brought its share of the growing agent bank merchant processing market to 20%.
TransFirst says it is still in buying mode and hopes to grow rapidly as more community banks decide that outsourcing this piece of their operations makes sense.
Small banks that do not offer merchant services often refer customers to acquirers, which pay the banks a fee. Those referral arrangements, however, have proven costly, since most large acquirers are also banking competitors.
"They're basically giving their client over for a small referral fee, rather than taking control of the program," said Marla Knutson, the president of TransFirst's agent bank services. "Now we're seeing a lot of banks that want to take control of this product."
Ms. Knutson said retailers want more information about rates and policies than they did before the merchants' antitrust class action against Visa U.S.A. and MasterCard International over debit card acceptance and fees. "They ask a lot more questions," she said. "We cannot expect our merchants just to trust us, like they once did."
Merchants understand that rates are set by Visa and MasterCard, not by the acquiring institution, Ms. Knutson said. Nonetheless, she said, "they want to understand the rate they are being charged, and it's important that we as processors supply them with the correct applications and equipment to allow them to receive the best possible pricing."
"Community banks need to know that they can pick a processor who will not compete with them," especially on the depository front, Ms. Knutson said. Small banks that do not offer merchant services have learned the hard way that the merchants that rely on them as depository banks tend to switch allegiances when approached by a larger bank - such as Bank One Corp. or J.P. Morgan Chase & Co. - that offers both, she said.
TransFirst provides training, risk management, and other front-end services to bank clients, who handle the merchant relationship. Back-end processing is turned over to Synovus Financial Corp.'s TSYS unit. TransFirst also processes health-care and government transactions. In 2001 it processed $8 billion of transactions, up from $3.1 billion the year before.
ICBA Bancard offers a similar package with the Atlanta processor Certegy Inc., a spinoff of Equifax Inc.
Scott Broughton, a senior vice president in charge of marketing for ICBA Bancard, said community banks face high demand for merchant services. "It's a very important service that local businesses need provided to them," he said. "If a community bank is not involved in that product … [merchants] will shop around and go somewhere else."
Community banks do not generate much revenue from merchant services, which Mr. Broughton described as a low-margin business but "a necessary service." Small players should see merchant services as a nice tie-in to other products, such as checking and money market accounts, loans, and liquidity services, he said.
According to the ICBA, almost all community banks outsource merchant services. "This is one area where they need a strong third party," Mr. Broughton said. Around 2,000 banks outsource some kind of work to his trade association, whose primary products include merchant services, he said.
Joni Floyd, a vice president at TransFirst, said many community banks would rather trust a vendor than another bank with this piece of their operations. She said her company is looking at a wide selection of possible acquisitions.
The Bank of America portfolio, which generates $3 billion of annual sales, was a "great transaction" for her company. Bank of America sold its agent bank portfolio because the business "was not complementary to what it was doing anymore," Ms. Floyd said. TransFirst, she said, thought it could manage the business better.
TransFirst, which began as ACS Merchant Services, said it has picked up 520 bank contracts and endorsements from community bank associations in New York, Colorado, North Dakota, North Carolina, Virginia, New Jersey, and Ohio.
Ms. Floyd of TransFirst said that occasionally one of its client banks will switch to another bank that runs its own merchant line. "Typically, if we lose business, that's where it's coming from," she said.
