What’s inside your core contract?

As the landscapes of core processing and financial technology evolve, community banks are carefully considering their long-term relationships with these central vendors. We look at how bankers might renegotiate or revisit core contracts with an eye on future innovation, flexibility and, potentially, cost savings.

By Karen Epper Hoffman

The relationship between community banks and their core processors has long been close but is often complicated. Now, as community bankers focus on innovating to stay ahead, as well as reducing overhead, these connections are as complex as ever.

Whether a core processing contract is nearing its end date, or a community bank is just looking to explore its options, many financial institutions are investigating alternatives to their core processor and the potential flexibility and collaboration a different core relationship might offer. Of course, those benefits are balanced by the price tag—including time and headaches—of making a switch.

Tom Moran, president and CEO of $430 million-asset Community Bank in Joseph, Ore., says the main issue today is essentially the same as it has always been: cost relative to value.

“Is the bank receiving enough value out of the relationship with the core provider to warrant the cost?” he asks, adding that there are many considerations that factor into both sides of this equation.

“On the cost side, there’s the significant capital investment [for the bank] and the ongoing maintenance costs and potential hardware expenses,” he says. Those ongoing maintenance and hardware costs generally fall outside of the scope of the overall agreement but are still usually considerable, Moran adds.

However, community bankers are expanding their vision of what they want from their cores and what they expect from these vendors. Despite the fact that, by most estimates, only 2% or fewer banks change their core processor in a given year, a recent survey cited in the January 2020 issue of Independent Banker found that nearly one-quarter of bank CEOs (23%) are investigating alternatives for core software, including conversions, upgrades and searching for open cores.

And, just as the banking industry has been consolidating in recent years, so, too, has the core processing business that serves them. After a spate of recent mergers and acquisitions involving payments processors, fintech startups and other core vendors, the so-called Big Three—FIS, Fiserv and Jack Henry & Associates—manage the core processing for the vast majority of community banks, according to estimates. As these and other large processing vendors grow organically and through continued M&A, they are also beginning to command more elements of their customers’ operations, including payments processing, digital banking, mobile banking, bill payment, remote deposit and online account opening.

“When it comes to core processing, there’s the Big Three and then there’s a little bit of everyone else,” says Ryan Rackley, a partner at Cornerstone Advisors in Scottsdale, Ariz. “The market penetration is drastically dominated by the Big Three, but there’s definitely good [core] platforms out there.”

And, as the processors have become larger and more diversified in their products and services, their contracts with bank customers have become more complex, too. Bankers, advisors and even executives from the cores agree that these contracts—which a decade or so ago usually ran 10 pages or fewer—now number as many as a few hundred pages. Now these contracts often incorporate more opaque legal language that can lock banks into additional services, beyond basic core banking, for longer periods of time than banks initially want to commit to—sometimes as much as a decade. They also sometimes impose stiff penalties and fees for ending contracts early or other changes, according to industry experts.

“These contracts have been ballooning in page count, especially as the Big Three have been acquiring [other vendors],” Rackley says. “These contracts are written by the vendors in most cases, and they are often highly negotiated.” Lately, he adds, these contracts may include commitments for an average of 20 ancillary services in addition to core processing.

“The contracts and invoices generated by big-box vendors have become so complex, even the attorneys and bookkeepers that review them are challenged to foot the contract back to the services actually being delivered.”
—Mark Dittman, IBT Apps

“The contracts and invoices generated by big-box vendors have become so complex, even the attorneys and bookkeepers that review them are challenged to foot the contract back to the services actually being delivered,” says Mark Dittman, CEO for IBT Apps, a mid-sized core banking vendor in Cedar Park, Texas.

And, since most deals have blossomed to include multiple services on top of the master agreement for core processing, banks are often agreeing to buy out multiple agreements with differing expiration dates if they choose to move to another provider or if they need access to past data.

But, despite the “influx of new entrants [and] the consolidating industry, the number of companies in the [core processing] business has not changed that dramatically,” according to Stacey Zengel, vice president of Jack Henry & Associates and president of Jack Henry Banking. “The big core processors have continued to evolve through acquisition and new development over the past years and I’d predict they will continue to do so.”

In the past decade, Jack Henry has acquired roughly 50 related businesses that fill out a portfolio of products, Zengel says. “Core processors will likely acquire other third parties or fintechs where it makes sense,” he adds. “We’ve always been open [to acquisitions] and encouraged customers to embrace one choke point and have historically allowed our customers to work with third parties if they feel the need to do so. We have published APIs that third parties can use to easily integrate into the Jack Henry solution set.”

Jack Henry offers integration through APIs with more than 200 other third-party vendors. “We will continue to listen to the market carefully,” Zengel says, “Offering integrated solution sets and allowing customers to have a choice to work with third-party point solutions through an open API strategy.”

Negotiating changes

John Blizzard, president and CEO of $730 million-asset Seattle Bank in Seattle, says that in an industry that is becoming “more commoditized,” community banks are “working for relevance” to compete with their bigger counterparts, typically through their use of customer-facing technology.

Seattle Bank is “working hard to deliver a high-tech, high-touch uniqueness to customers,” Blizzard says. He adds that the digital and tech focus has become all the more critical during the ongoing pandemic and the limited access to in-person banking.

“This current environment has made community banks more valuable,” Blizzard says, adding that many customers have flocked to his and other community banks to receive better customer service and more support in utilizing their Paycheck Protection Program (PPP) loans. But in this “current crisis” and other landscape changes, Blizzard points out that community banks must step out of their comfort zones, consider more carefully their core and ancillary service providers, and often work with different or more nimble technology providers, particularly for their digital or customer-facing services.

“We can’t just continue with old ways of doing things,” Blizzard says, adding that “most bankers have no idea what they really pay for a core contract. I had no idea till three years ago.” Without paying closer attention to their cores, their cost and fees, and the other options available, banks have “no control over their tech stack.” “Ten, 15 years ago, that was not really an important part of the business,” he adds. Nowadays, with digital and branch services relying more heavily on connections to back-end operations and data, it has become more critical to success.

Even if a community bank can define how much its core contract actually costs for upfront services, including potential penalties and fees, “there are also costs that can be harder to define,” such as opportunity costs, choosing a traditional core vendor over an emerging fintech or vice versa, and the time and effort to change providers, Moran says.

“We have to ask, is the bank foregoing a better, but less traditional vendor solution? How long is our commitment? Outside of performing the basic, expected functions, how intuitive is this system to use … for both customers and bank personnel?” he asks. “And how flexible is it? Will it play nice with other bolt-on technology providers’ systems?”

Community bankers must also concern themselves with “uptime,” service-level agreements (SLAs) and security. They should be aware of how often a system may go down or be breached, the level of vendor responsibility if it does and the bank’s potential recourse. “Arguably, the most important role a bank will play in the lives of its customers is the protection of their private information,” Moran says. “The core provider is a critical component here.”

Cores in the cloud

But there are other changes afoot in the core landscape, namely the ongoing shift from licensing on-premise core services to the application service provider model, typically outsourced and in the cloud, according to Brookfield, Wis.-based David McIninch, senior vice president of strategy and product management for account processing at Fiserv. While he maintains that core consolidation “hasn’t significantly changed the market share,” this increased move to more varied, outsourced, cloud-based services has changed “operating leverage and flexibility, contracts and pricing, and options.”

Among many large deals for core processors, Fiserv initially announced its acquisition of First Data Corp. in January 2019. “We are still quite active in [looking at] strategic acquisitions we can make,” McIninch says. “If you think of the total spectrum of financial technology … a bank’s approach to their partners is becoming much more important.”

While the core banking services “will always be the cornerstone, banks will bring fintech into the equation more and more. That’s the future of our industry,” McIninch adds. “The ability to provide these tools, and to be more flexible to work with [other vendors] is much more important than 24 months ago. The adoption curve for digital solutions has steepened dramatically given the impact of COVID-19 and shelter-in-place orders.”

Austin, Texas-based Giovanni Mastronardi, group president of enterprise banking at CSI, another mid-sized core provider, says CSI’s bank customers are increasingly asking for performance and uptime commitments in their contracts, “with accountability [for the processor] and giving the bank the right to exit the contract with no penalties if there’s nonperformance.”

Until recently, many core processing contracts lacked teeth, even if they laid out performance “standards.” Or, in other words, the processors did not face any financial repercussions or penalties for not meeting those targets. On the other hand, banks might have to pay steep penalties for changing processors, or deconverting, sometimes as high as seven figures or more. Nowadays, more banks are insisting on service-quality and uptime agreements with “defined fees for deconversion”; better bundled pricing for multiple services with flat, reasonable adjustments annually; and pricing that’s predictable and easily understood, Mastronardi says. He adds: “They want to have it clearly spelled out, because that’s been a moving target for most banks.”

Moving forward

While the banking and fintech space “has clearly moved forward and continues to rapidly evolve, the negotiating exercise between banks and core processors really hasn’t progressed fast enough with these changes,” Moran says, “which is why you hear bankers venting their frustration about it at just about every bank conference. The contract fees are generally still structured the same, and the barriers to exit [contracts] are still gigantic.”

To help them make their case, Rackley recommends community banks “use their leverage at the negotiation table.” This means coming in with a strong, well-researched plan for what the bank requires in terms of performance and integration with outside providers; and what penalties and terms are acceptable, including fees for merging or deconverting and accessing bank information after a contract with the processor ends.

“It all boils down to choice. The biggest mistake many banks make is to allow the contract to auto-renew.”
—Ryan Rackley, Cornerstone Advisors

“It all boils down to choice,” Rackley says, adding that a bank’s position is strongest when their contract is up. “The biggest mistake many banks make is to allow the contract to auto-renew.” Anecdotally, Rackley estimates 40% of banks have an outside consultant help them review and negotiate contracts, as opposed to just one-quarter five years ago.

However, “cost alone is not the most critical thing,” Blizzard says of banks’ contract priorities. Lately, financial institutions like Seattle Bank are as interested in implementing fintech services as they are in being able to assert more control over their data and their customer services. “The financial piece makes it very difficult to leave unless you time it right,” Blizzard adds.

Industry experts suggest that bankers pay close attention to exactly when their contracts are coming due, so that they can begin their research, planning and vetting process at least two years before the end of their core processing term, giving them more room to explore their options.

Even with more strategic planning, a tiny number of community banks switch cores in a given year due to the cost, difficulty and confusing options. Blizzard, whose Seattle Bank recently changed core processors, suggests that fellow community bankers “look for a partner, not a vendor, with a similar business model alignment, so your success is theirs.” Be upfront about priorities that are required or merely desired, he adds.

“We have to innovate to stay relevant, and that starts by taking control of our tech stack. Community banks are incredibly entrepreneurial and innovative, if given the chance.”
—John Blizzard, Seattle Bank

“We have to innovate to stay relevant,” Blizzard says, “and that starts by taking control of our tech stack. Community banks are incredibly entrepreneurial and innovative, if given the chance.”

Karen Epper Hoffman is a writer in Washington state.