Bank stocks and financial services may be entering a Golden Age.
Our entire lives revolve around financial transactions. Financial services are so wrapped into human experience that one cannot be functional in any way without them, which is why bank stocks should be core to your portfolio.
I foresee two big things coming down the pike for this sector which should convince you to get some sector exposure if you don’t have it already … and increase any positions in bank stocks you already hold.
First, consumer demand is creating the need for innovation. We’re starting to see it with Apply Pay, from Apple (AAPL). The “sharing economy” is forcing businesses and consumers to re-think how transactions occur. Peer-to-peer lending appeared a few years ago. This is just the tip of the iceberg.
Second, the Dodd-Frank law has not been the big saving grace for consumers that the government intended it to be. That’s because every time Congress, regulators, or the CFPB tries to put the kibosh on some kind of banking product or fee, the banks come up with some way to replace that income.
Apparently, government hasn’t figured out that price controls don’t work. That’s especially true with financial services, because there are so many transactions that occur with consumers that if one fee gets capped, banks will just charge a fee for something else.
As long as government keeps getting in the way, banks will be forced to get creative about new sources of revenue, or return to ones that got an undeserved bad rap in the media.
The Next Big Thing for Bank Stocks
As an example, let’s take a product that has gotten a bad rap and which banks should return to offering: payment protection. This is sometimes known as credit insurance or debt protection.
These days, everyone is focused on credit scores, and everyone tries to keep their credit score from being negatively affected. As Americans have been levering up again after a 5-year period of credit de-leveraging, the need for credit insurance is growing.
Most Americans are underinsured in life, health, auto, and/or home coverage. Given that most people carry some kind of balance on some kind of credit account, all it takes is one minor life setback to endanger a payment and with it, a credit score.
Here are a few examples of pitfalls that can happen to anyone. A car accident, whether or not caused by you, could result in paying for an expensive deductible, or worse. If you need a car to get to work, you’ll need to pay that deductible and it means you may miss a credit payment of some kind.
Individual disability coverage can be difficult to obtain and can also be very expensive. If you become disabled, even for a short period of time, you will lose your cash flow and with it, ability to make payments. Even if you are insured, most individual policies also have a somewhat lengthy waiting period before they pay, potentially leaving you exposed.
Obamacare has not resulted in the kinds of savings that were hoped for. Many policies have high deductibles. What happens if you have a medical issue that arises and forces you to put up money for medical care before a credit payment?
That’s why I think most Americans are underinsured when it comes to their cash flows — they need a product like credit insurance to mitigate their financial risk. I believe financial service companies know this, and will find ways of offering cost-effective credit insurance products more frequently.
Contrary to popular belief, and even my own expectations, credit insurance is actually both a really good idea and affordable.
Credit Insurance Is Just the Beginning
See, I always scoffed at credit insurance and debt protection that came with my credit card statement. I always pay on time and always have good cash flow. However, I realized I was exposed if I became disabled or had a huge medical issue that wasn’t covered by insurance. Credit insurance, it turned out, made a lot of sense — even for a skeptic.
It turns out that credit insurance is offered at the point of sale, and for a very reasonable price considering what it covers. Yet, because payment protection products weren’t marketed or sold in ways that the CFPB approved of, the banks ran away from it. I believe, however, that they will return to it because of consumer demand. This time, they will have detailed methods of marketing and sales so as to remain in compliance.
None of these individual innovations, or legacy products like payment protection that will see more usage, are going to be cash cows for banks. The point is that these are valuable consumer products, which, if done well, can be very successful.
I believe there will be more and more of these products appearing on the horizon. Banks want to enhance relationships with consumers, because it increases “share of wallet,” as they say. Everybody wins — especially bank stocks.
What does that mean for you, as an investor? As I said, you need to have financial services exposure in your portfolio. This could mean Bank of America (BAC), Wells Fargo (WFC), US Bank (USB), Citigroup (C), JPMorgan Chase (JPM), and just about any other bank stocks.
I also wouldn’t put it past Visa (V) or Mastercard (MA) to offer new products, as well, even though they are not actual creditors. You will probably also see it from any number of insurance companies.
Alternately, if you’re just looking for a broad way to pick up bank stocks and play the financial innovation trend, you could do a lot worse than going with the Financial Select Sector SPDR ETF (XLF).
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he was long BAC. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.