Though Disappearing, Substitute Checks Create Opportunity for LPSI

A Dublin, Ohio-based startup is leveraging air-courier logistics and aggregation efficiencies to wring revenues out of a dying business—the so-called substitute check. Liberty Processing & Services Innovation went live only five months ago and is now printing and delivering about 3 million checks a month on behalf of five client banks, including three of the largest in the country, according to Earl Jennings, a former JPMorgan Chase & Co. executive who serves as LPSI’s chief executive. He says he can’t name his clients.

Jennings has no illusions about the self-liquidating nature of this business. Check image exchange has driven the monthly volume of substitute checks down to 12.2 million as of December 2010, or a tiny 0.09% of total image-exchange volume, according to the Electronic Check Clearing House Organization, Dallas, which writes the rules for image exchange. That’s down from about 300 million in October 2007, the high-water mark for the paper items.

But Jennings argues there is still plenty of paper in the system, creating an opportunity for entrepreneurs. Indeed, while most observers concluded long ago that substitute checks—the paper printouts collecting banks make for paying banks that can’t accept check images—had mostly disappeared, LPSI is already handling about a quarter of the available substitute checks, based on ECCHO’s numbers.

LPSI, Jennings says, can serve as an aggregator to connect collecting banks with paying banks with which they have no correspondent relationship. The company also handles return items,  and delivers its services at prices that compare favorably with fees charged by the Federal Reserve, he says. “”I don’t think [banks] are going to give me the business because I’m a nice guy,” he notes. He declines to discuss LPSI’s pricing, saying it varies by client.

Nancy Atkinson, a senior analyst at Aite Group, a Boston-based payments research firm, points out that the startup’s service can appeal to large collecting banks that otherwise face rapidly escalating costs for the dwindling volume of substitute checks they must print. This could ensure a large share of volume to LPSI even as that volume continues to decline, she says. “Big banks don’t want to build out this capability, but they are the ones getting hit more,” she says, because they handle more such items. And, she says, LPSI may have the market all to itself. “I don’t think [Jennings] is going to have a lot of competition for it,” she says.

At Chase, Jennings helped build the bank’s capacity to handle checks under Check 21, the law that spurred image exchange and authorized the substitute check as a legal document. In January 2010, he and three partners founded LPSI. Now he oversees an operation that prints, bags, and delivers checks in sync with the wheels-up times of United Parcel Service’s fleet of aircraft stationed in Louisville, Ky.

With printers set up at an operations hub about 20 minutes away from UPS’s planes, LPSI prints and bags checks and hands them off to UPS personnel who share space at the facility. They carry the checks to waiting planes. Bags are already sorted by geography and by paying bank. On arrival, UPS agents take the bags off the plan for delivery. The operation is designed to maximize efficiency and minimize settlement time. A plane leaving at midnight, Jennings says, can have checks at the paying bank by 8 a.m.

Now Jennings is looking at other paper-intensive operations within banks, such as mortgage processing. “We recognize the shelf life [of substitute checks] is very short,” he says. “The intent here is to help banks transition from residual paper.”