Here’s Why Square Inc (SQ) Stock Is Worrying Regional Banks

Though whispers of the possibility have been circulating for months, it was only in early September the company confirmed it. That is, Square Inc (NYSE:SQ), which provides a credit-card payment solution that’s stunningly simple for small businesses to use, is also looking to become a bank. In so doing, it will be able to make loans to anyone, though it’s aiming to first offer loans to users of its credit card acceptance service.

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It’s an exciting development to owners of Square stock, who have already seen the their SQ stock price nearly triple in just the past twelve months. Although it’s not clear to what extent (if any) the new business venture might boost the top and bottom line, it’s at least an opportunity to drive some growth. That’s all investors can really ask for.

Thing is, the opportunity for Square’s banking ambitions may be enormous. The evidence? Just look at how desperately loudly the would-be bank’s future competitors are already wailing.

Too Much Protesting?

Invoking the words of William Shakespeare is cliche to be sure, though appropriate right now, of the banks that have something to lose by Square getting into the banking business: “The lady doth protest too much, methinks.” In this particular case, the Independent Community Bankers of America (ICBA) has penned a letter of protest to the FDIC, suggesting Square’s bank charter, if granted, would allow the company to circumvent legal prohibitions and restrictions, as described by the Bank Holding Company Act.

It’s an oddly weak argument, for SQ stock owners that were concerned.

To fully appreciate the nuances of the brewing-but-mostly-hollow legal headwind, one has to understand the nature of different banking licenses.

Most banks, and regional banks in particular, like U.S. Bancorp (NYSE:USB) or even larger players like Bank of America Corp (NYSE:BAC) opt for a traditional bank charter that allows them to make loans and accept deposits insured by the FDIC. Those banks may do other things like offer brokerage services or provide investment banking options, but a clear wall is drawn between the various functions of the bank.

An industrial loan charter, however, allows the bank in question to do other things besides making loans and accepting deposits, yet keeps the entire operation under one fiscal umbrella. In Square’s case, the other operation is continuing to facilitate credit card payments using the small device that attaches to most smartphones, allowing for an easy swipe whenever and wherever.

The ire from small banks is completely understandable. Though Square says it only is interested in meeting the needs of its payment-processing customers, becoming an industrial loan company sets the stage for Square being able to steal customers from those relatively handcuffed community banks.

In other words, Square is effective, efficient competition community banks (and larger banks for that matter) don’t want to have to deal with. That, however, is not reason enough for the ILC charter to be rejected, or even postponed, regardless of the ICBA’s outcry. These entities are still regulated. They’re just overseen in a different way by a different entity in the states where ILCs are allowed.

It’s the scope of the ICBA’s lamentations, however, that underscore the potential the industry’s existing players see in Square’s new venture. Their worry bodes well for SQ stock, even if shares themselves are technically overbought in the near term.

Bottom Line for SQ Stock

The small business lending market in the United States, as of 2013 anyway, consisted of about $1 trillion worth of loaned money. That figure is likely to have grown in the meantime, with companies like LendingClub Corp (NYSE:LC) and SoFi meeting a need for capital that simply hadn’t been met by any bank, large or small, prior to their rise.

Even a small fraction of that market would prove to be a boon for Square, and with its two million(+) payment customers in tow, it’s well positioned to capture a healthy piece of the small business lending market.

The irony is, the customers Square would be making loans to are largely the same customers banks, large and small, rejected in the past, calling them too much of a credit risk and/or not asking for enough money to make the loan worth the bank’s while. Big mistake. Those community banks failed to build a relationship, and failed to recognize small business customers can become bigger borrowers later. The banking industry also, in general, fails to accurately assess a small business’s prospects.

Now that way of thinking is coming back to haunt traditional lenders.

Whatever the case, Square’s banking plans (assuming it wins approval as an industrial loan company) is as big of a deal as its future competition is making it out to be.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter.

Article printed from InvestorPlace Media,

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