Betting On America's Underbanked

By Aaron Levitt | April 27, 2011 AAA

While the microfinance revolution in emerging markets is well known, an equally compelling story is happening on our shore. It's hard to believe, but there is an ever-increasing group of Americans that lack access to a bank account. With so many people still reeling from the effects of the Great Recession, the population of underbanked and unbanked citizens keeps growing. According to the FDIC, nearly one in 13 households doesn't use a checking or savings account. Representing a staggering $1.1 trillion in government welfare and employer paychecks annually, there are opportunities for investors in the sector.

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Sixty Million Americans
About 60 million Americans fall under the category of being underbanked or unbanked, with nearly 7.7% having no account at all. This term refers to families without a traditional checking or savings account or those who have a bank account but still choose to rely regularly on "alternative financial services". According to the FDIC, these people feel they cannot make use of a traditional bank due to insufficient assets, lack of social security numbers or that unbanked households saw no value in having an account. Additionally, distrust for the nation's 13,000 banks is a growing concern. This is similar to the financial skepticism that was patterned during the Great Depression. The FDIC further states, that about 41.1% of the unbanked households said they are "not likely at all" to open a new bank account in the future.

These underbanked households are disproportionately low-income/minority. Traditional banks have done a poor job reaching them and a variety of alternative financial service (AFS) providers have crept into the market attempting to fill the void. These companies offer services like check cashing, payday loans, pawn shops and prepaid debit cards in place of traditional accounts. These businesses pocket more than $10 billion in fees each year from the check cashers and payday borrowers. Industry group Mercator Advisory forecasts that the prepaid debit card market will expand at an astonishing 92% compound annual growth rate until 2012 and will reach $118.5 billion in annual funds loaded. The payday lending industry has grown dramatically as well. In 1990, there were about 500 payday locations. Today, that number sits at well over 22,000.

The Final Banking Frontier
With retail banks facing stagnant revenue growth, many are vying for a foothold in the "last frontier" of the domestic banking market. Traditional banks like Wells Fargo (NYSE:WFC) and KeyCorp (NYSE:KEY) have begun to offer services for these consumers. However, smaller more nimble direct players may offer the best opportunities for investors looking at the sector.

With the explosive growth in the prepaid debit card industry, investors should take a look at Green Dot (Nasdaq:GDOT). The company is the dominate player in the industry and boasts more than 3 million active cards. More prominently, Green Dot has partnered with Wal-Mart (NYSE:WMT) to provide financial services to its customers. Wal-Mart estimates that one out of every four of its customers is unbanked or underbanked. Shares of the company are trading nearly $20 below its 52-week high. Smaller rival Netspend (Nasdaq:NTSP) also recently went public, and could be a good bet.

Offering a 4.9% dividend yield, Advance America (NYSE:AEA) is one way to play the growth of payday loans. However, with regulatory hurdles looming for the sector, investors may want to stick more conventional pawn shop plays. Both First Cash Financial Services (Nasdaq:FCFS) and EZCORP (Nasdaq:EZPW) are great examples in the industry.

Finally, for investors wanting more of stable play on unbanked America, Western Union (NYSE:WU) and Coinstar (Nasdaq:CSTR) are dominate leaders in their respected categories. These companies offer a safer way to play the theme.

The Bottom Line
With the effects of Great Recession still lingering, the amount of unbanked and underbanked continues to grow. With analysts predicted tremendous growth for the industry, investors may want to consider adding the sector to portfolio. The previous stocks along with companies like Cash America International (NYSE:CSH) make interesting choices. (For additional reading, also take a look at 8 Ways To Avoid Getting Burned By Prepaid Debit Cards.)

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