Consolidation drives data processing innovation
Much like — and perhaps in part driven by — the consolidation in the banking industry, the number of core processor providers has dropped drastically in the last decade, even though the technological services are in higher demand than ever. (See related banks mergers and acquisitions roundtable on p. 16.) Just this spring, Vista Equity Partners paid more than $2 billion for D+H Corp., creating a $4.8 billion giant of a banking software provider.
A Minneapolis-based senior sales executive at Fiserv, Kent Conrad, estimates there were four times as many core vendors only 20 years ago, although they were servicing twice as many banks. The parallel trends share some common causes.
“It just has become very difficult to keep up with the regulatory requirements and the expectations of our customers, the banks’ customers,” Conrad said. “In order to do that, you really need some pretty hefty financial resources, some pretty deep pockets, a very good income stream in order to be able to support the changes that have occurred and will occur more quickly as we move down the road.”
Conrad expects even further consolidation among processors. The costs of regulation combined with the rapidly developing technological advancements necessitate it in order for some to survive. Here, though, the parallel halts. A large difference between the two industries emerges. There are few, if any, new banks. Meanwhile, a new fintech company pops up frequently. Each new fintech represents another acquisition opportunity for one of the big four core providers (D+H, FIS, Fiserv, Jack Henry & Associates).
Steve Heston sees some of those combinations as intentional from the outset, not that there is anything wrong with it as a business strategy.
“Whether you’re a fan of the consolidation or you’re concerned about the effects of consolidation, it’s not going to slow down anytime soon,” said Heston, the chief sales and marketing officer at SHAZAM in Johnston, Iowa. “Some of the coolest start-up fintech companies, their stated plan is to get acquired by one of the big guys. That is their exit. That is why the investors put money into those companies.”
The new fintechs and other smaller core processor providers are often able to be more “creative,” said Bob Neville, president of Modern Banking Systems, Ralston, Neb. With fewer layers of red tape slowing them down, they can drive innovation. That is when a company such as Jack Henry shows up, recognizes a promising idea and continues those overall consolidation trends by making a purchase.
Jack Henry Banking President Stacey Zengel sees this strategy as a way to navigate between being on the bleeding edge versus being on the leading edge. Once a fintech company establishes itself as on the right path, Jack Henry can avoid some of the risk of pushing the envelope while still reaping many of the rewards. Zengel expects this to become more of a norm, which makes sense as there are consistently fewer providers around. Remaining independent becomes more difficult.
“If we saw something out in the market we thought we might need to have, then we could look into acquiring the business,” Zengel said. “We’re primarily geared toward looking for new business opportunities.”
Is this consolidation best for bankers?
The core processor food chain provides a path for innovation to turn to industry-wide growth. Investors fund a new idea. The new idea succeeds. Rather than attempt to replicate the new idea on its own, a bigger company acquires the newbie and integrates its product as necessary.
K.L. Templeman, chief operating officer at the $441.6 million TrailWest Bank, Lolo, Mont., has been involved in five conversions of core providers in her 23 years of banking. On top of those, she points out TrailWest needs vendors for online banking, debit cards, a mobile app and so on.
“We don’t necessarily believe having one vendor is the right approach,” Templeman said. “It does simplify things. There’s only one person to go to. But, you lose some of your leverage in your availability of options; you lose some power in negotiations on pricing.”
So as vendors merge at a rate double that of banks, at least by Conrad’s rough estimates, Templeman sees only the loss of her preferred operations approach.
“We are losing that choice, that ability to have choice … Options dwindle. Costs increase.”
This is not a sentiment shared only by bankers. Heston agrees with Templeman. Even if using multiple vendors might make aggregating and analyzing data more difficult for an individual bank, Heston argues the various providers have a duty to make that collaboration possible.
“We believe this whole topic comes down to the importance of choice and flexibility,” Heston said. “In the time where technology and the banking profession are evolving at a different pace and maybe a faster pace than historically, it is critical that the institutions have the ability to choose the best of providers or best relationship providers for whatever piece of technology platforms they want.”
There is a risk to sticking with the smaller providers, though. Even Neville recognizes the concerns a community banker may have about hitching their operation to a relatively smaller core processor such as his. A decade ago, most small banks expected to be around come 2017. If not having shown growth, they would presumably have at least expected profitability. Instead, there was a recession.
Of the many parallels Neville draws between Modern Banking Systems and a community bank – similar philosophies, an emphasis on personal service, access to the top decision-maker – he includes one that might sting a little.
Bankers are concerned that competition and regulation threaten the existence of some core processors. Will they be able to compete? Neville said bankers have had the same question about core processors as they have about themselves. “With regulations, will we be able to compete in the future?” Neville asked.
Bankers are comfortable with larger core processors. “They know this guy is going to be around,” he said.
Then again, Neville points out, if a community banker believes his or her bank will be around long enough to sign a five-year contract, why not believe in the similarly-sized and similarly-focused vendor?
Consolidation or not,big or small, what’s next?
As with all endeavors involving technology, security emerges as a top concern.
“My pipe dream is that customers would understand that sometimes security isn’t easy,” Templeman said. “While we try to make things as convenient as possible, there are cases that require multifactor authentication or other security steps that are in their best interest.”
When pursuing security, vendors balance it against utilizing data to better serve the banks’ customers. In some respects, they walk hand-in-hand. When Jack Henry detects fraud on a credit card, it is often because its systems have learned the individual’s spending habits. Interpreting those same tendencies can educate a bank about the individual’s needs.
As data mining and analysis become more commonplace, the cost barrier has diminished to an extent the data applicability is increasingly feasible for most community banks, per Zengel. In its own way, this is also due to the consolidation within banks. By definition, they are getting larger themselves.
“I would say customer privacy with data privacy issues are prevalent, but I’m sure if you use internet applications, you’re used to your data being mined, as well,” Zengel said. “Banks probably haven’t used as much customer data and analytics, especially the community banks, as they really have available to them.”
Artificial intelligence advancements will only further the banks’ abilities. Neville expects a day when banks not only use data mined from a customer’s accounts and cards, but also keeps a digital eye on the customer’s social media activity. If a Twitter post mentions a need for a good realtor, the bank can begin preparing mortgage possibilities.
“The data analytics and the artificial intelligence, that whole world is really where a lot of this is going,” Neville said. “Fintech companies know that. Those guys are out there, and they’re seeing that in these opportunities.”
With that foresight, those fintech companies will ready themselves for purchase by a bigger company. Jack Henry’s most popular phone app solution at the moment is called Banno. Only three years ago, Banno was an upstart fintech company.