Banking has evolved rapidly over the past decade or so, and this could be just the beginning. Companies like Amazon.com (NASDAQ:AMZN) and Square (NYSE:SQ) could threaten the big banks' dominance in some key areas, and in this episode of Industry Focus: Financials, host Jason Moser and Fool.com contributor Matt Frankel discuss some of the key trends, news stories, and future catalysts in the financials sector that investors should watch closely.
A full transcript follows the video.
This video was recorded on Sept. 24, 2018.
Jason Moser: It's Monday, September 24, and welcome to Industry Focus, the podcast that dives into a different sector of the stock market each day. I'm your host, Jason Moser. On today's Financials show, we'll talk about the changing face of banking, we'll tap into Twitter for a listener question or two, and we'll wrap it all up with One to Watch. Joining me today is certified financial planner Matt Frankel. Matt, hope you guys are recovering from the storm OK there in Columbia.
Matt Frankel: Oh, yeah. It's beautiful weather this past week. We got a lot luckier than the people to the north of us.
Moser: That's good to hear! Sounds like it was a pretty good weekend for your South Carolina Gamecocks. They laid the hammer down on Vanderbilt, it looked like.
Frankel: Yes, sir! We have Kentucky next week. Hopefully we can keep it going.
Moser: My beloved Wofford Terriers had the week off, so no football there. I think we're visiting Gardner-Webb this weekend. We'll revisit those scores next Monday. Hopefully we'll have a couple of wins to talk about.
First, I want to start this week's episode talking a little bit about Facebook (NASDAQ:FB). We were reading an article here last week in regard to Facebook, and relationships they've been trying to forge with banks. It seems like they've been trying to forge these relationships for a long time, even well before all of these recent data concerns. The data concerns, of course, that just came out, I think it probably cast a shadow of skepticism over Facebook, what it's really doing with our data, how much it really cares about our privacy. When I read about Facebook and I hear banks mentioned in the same conversation, I start to get a little bit curious as to how users really would feel about the two being tied together.
Now, I'll preface this by saying, Matt, I'm not a Facebook guy. I had a Facebook profile once upon a time, but I closed it and left that platform. It just wasn't for me. I don't use Instagram, I don't use WhatsApp, I don't use any of their stuff. I know I'm obviously in the minority here.
I want to kick it off to you here. From the very get go, when I think about Facebook trying to get relationships with different financial institutions, for me, I think more about the financial institutions. Why would a bank want to give up that data to Facebook? I mean, is the upside for the bank really worth it? I would assume Facebook would make it worth their while financially in some regard. But is the upside really worth it?
Frankel: Facebook says that they just want all this data just for purposes of enhancing customer experiences. But, they can use the data they get from financial institutions for targeted ad purposes, as well. That's where banks don't really like this that much. They want to keep their customers' data as secure as possible. Customers don't really want their data used for those purposes in many ways. So, banks have been very resistant to this. Some banks have made individual deals with Facebook.
Just to give you an example, AmEx has a private chat bot on Facebook's platform. They made a special deal with Facebook, where they give some data directly to Facebook, but Facebook can't collect data from AmEx's secure chats. Bank of America (NYSE:BAC), for example, chose to keep all of their private messaging off of Facebook's platform for this reason.
It doesn't really look like the banks think that they have a lot to gain by allowing Facebook access to their data. A lot of them have been very resistant so far.
Moser: I feel like when Facebook talks about wanting to enhance the user experience, to me, that's just code for selling more ads. That really is Facebook's bottom line at the end of the day. This is an ad play. For investors, if you're looking at Facebook as an investment, this is an ad play. It's not to say that's a bad thing. Obviously, Alphabet has done very well with an ad model. We see plenty of businesses that do very well with an ad model.
I guess I wonder, can Facebook at this point really be anything other than an ad play? I know they're talking about releasing some hardware here that's sort of a chat function, similar to an Amazon Echo. I'm not really sure I'd give that thing a chance. It seems like it's a little late to the game. But I just wonder, at least in the near term -- and I'm talking about next three to five years -- do we look at Facebook as anything other than an ad play?
Frankel: Not really. I really don't think Facebook has much ambition when it comes to banking itself. I don't really think that they're going to evolve into much more than an ad play. Like I said, they want this data mostly so they could target ads. Facebook's old policy before all these data issues came up, it used to be that they could use all available data to present the most targeted ads possible to customers. Now that they've gotten pushback, they've modified their policy a little bit. But at the end of the day, Facebook just wants to sell ads and use this data to target those ads so they can charge top dollar for them. It's not really a play toward getting into banking, or any consumer finance at all. I think they're just going to stay at ad play.
Moser: Yeah. It's always worth noting, consumers volunteer this information up on Facebook. It's not like they're twisting your arm. They've done a very good job building a platform here that more or less connects the world. You can use it, or you can choose not to use it. If you use it, it's not like you're paying anything for it. They have to support that some way. Selling ads is a reasonable way to do it. I think in today's day and age, if you use the internet, you have to go in there with the assumption that some of your data is just up for grabs, right? I certainly don't go into any of these types of stories thinking that my data is always going to be under lock and key. That's just not the way things work these days.
Speaking of big companies that are burning trust like it's firewood on a cold winter's day, let's talk about Wells Fargo (NYSE:WFC). I was reading an article here just the other day, CEO Tim Sloan said on Thursday, Wells Fargo plans to cut 5-10% of its workforce. Of its workforce! They have 265,000 people that work for the company today, so we're talking somewhere in the neighborhood of 25,000-27,000 people they're talking about trying to get rid of here in the next couple of years as banking moves more digital.
This isn't really, I think, a new story. We've been talking a lot about this lately, how banks with this huge physical presence -- now, you see a banking center on every corner, it seems like, these days. They're seeing more and more that you want to go to the bank like you want to go to the dentist. You just try not to do it. Right?
Frankel: Yeah. Banking's definitely moving more digital. Tim Sloan specifically referenced increased efficiency when this announcement was made. They have to see all these other smaller fintech players as a threat when it comes to these layoffs, as well. They know their business model isn't really working anymore as is. They're not just downsizing branches, but trying to rely more on their mobile and online platforms, and just making their operation run a lot more efficiently to compete. A lot of that is, their hand is being forced by some of these fintech players that we're about to talk about.
Moser: Yeah, I was reading a little bit earlier in the week on how the younger generation -- I'm talking about our kids, my kids, your kids -- they're growing up in a day and age here where finance is being viewed very differently with money-transferring apps like Venmo and Google Pay, Square Cash. I saw the stat, American teens today are four times less likely to use cash than ever before.
That has certain implications, right? For the most part now, kids are trying to figure out ways to get about without having to use cash whatsoever. That means that they need to use a banking system in some way, shape, or form. Certainly, there's a place for Wells Fargo in that story. But to me, it seems like now, more than ever, these big banks that have done so well for so long with this big physical presence, whether it's Wells Fargo or Bank of America -- really, those are the two that come right to mind -- they have some very bloated cost structures that I think they're going to have to come to terms with here over the coming five to 10 years. Like you mentioned, those nimble little start-ups there, that are becoming a lot bigger than start-ups these days, have big advantages because they don't have that bloated costs structure.
I was talking to my daughter last night, she came back from a babysitting gig. She got $20 for babysitting. It was $20 cash. She's looking at this $20 bill, and she's thinking, "What do I do with this? I mean, I've got a wallet. I guess I could put it in there and spend it at some point." But she's looking for someplace to put it where it can be safe. And I was thinking, maybe this is an opportunity for us to go open up a Square Cash account for her, and she can give me the $20, I can transfer it over to her account, and then she's got her money, it's safe, and she doesn't have to worry about losing it. Like we're talking about, the changing face of banking.
Along with that, Amazon Prime -- which is the relationship now that seems like you probably should get it along with your social security number and Netflix subscription when you're born -- Amazon is at least being thrown around here in this banking conversation. Recently, Bain surveyed 6,000 U.S. consumers, asked them, if Amazon launched a free online bank account that came with 2% cash back on all Amazon.com purchases, would you sign up to try it? It was very interesting. The response there, almost 70% of those in the 18-34 age bracket said they would try it. About 50% in the 35-54 year old bracket said they would try it. Under 40% of those older than 55 said they would try it.
This makes me think about one of the greatest advantages banks have these days. I'm in that age bracket where I'm 35-54, and I'll just leave it at that. We've got this Bank of America account that we've had now for years. We have it because it was convenient at the time. It's become even more convenient with the online banking options. Frankly, we have so many things that are tied to this account now. Automatic deductions that come out, whether it's insurance or our mortgage, or just household bills every month, we have so much tied to this account and that banking relationship, it would be a lot of work to try to sever that relationship. There would probably be a lot of problems that come from it. It's not worth the work. I don't really bank with Bank of America because I love Bank of America. It's a means to an end. It would just be way more work at this point to quit.
For younger generations that don't have banking relationships yet, they're going to see this a lot differently. I think this question with Amazon comes up. I wonder, from your perspective, is it worth Amazon even fishing in these waters?
Frankel: Maybe. One of the more interesting statistics from the survey that you just mentioned that I read was that 37% of people who don't even shop on Amazon right now would try an Amazon checking account if it gave them 2% rewards. That was one of the most interesting things that I saw. This could be a way for Amazon to bring even more customers into its ecosystem.
Having said that, I really don't see Amazon getting too deep into the banking business. One, it brings up a ton of regulatory headaches. Two, it's becoming a more crowded space. If Amazon, say, developed a brokerage platform, would people switch? Would I drop TD Ameritrade to go to Amazon? Probably not. If they had a personal lending platform, would people stop going to the more established personal lenders and go to Amazon? Probably not. I don't think it would be worth the regulatory headaches especially. And it's just not really a business Amazon really needs to be in now.
That said, I could definitely see them partnering with one of the big financial institutions. It's known that they've been in talks with JPMorgan Chase and Capital One, for example, when it comes to developing this checking account. I could see them doing what they do with their credit card -- putting their name on a credit card that's issued by another institution. So, JPMorgan Chase Amazon free checking, something to that effect. I could see them partnering with an institution. I don't see them becoming the bank itself.
Moser: I think that makes sense. I've got that Amazon Prime Visa (NYSE:V) and I've been really happy with it. We're Prime members, of course, so we make that money back in shipping just on toilet paper every year alone. But an Amazon Visa card, you look at the rewards, you get 5% cash back on purchases from Amazon.com and now Whole Foods. You get 2% back at restaurants, gas stations, drugstores, 1%, back on other purchases. So, you're right, they do a really good job of partnering up with leaders in that space, where they can offer a compelling value. I think with Amazon, the focus is always trying to figure out how to be as customer-centric as possible.
It takes me back to one of the things, I have seen it time and time again as an investor, it's one thing I've learned -- even if a company has the financial resources to do something, doesn't necessarily mean that they should. It's very difficult to pick up share on companies that have a big lead and already do something really well. I don't know that Amazon could really offer a checking account or a banking account and do much different than is already being done by a lot of the major players out there today. I think partnering up probably makes a little bit more sense, like you're saying.
I guess we'll see. Walmart certainly tested those waters a number of years back, and I guess they decided, ultimately, the juice wasn't worth the squeeze, as they say. Amazon is certainly trying everything they can to gain a little bit of an entry, it seems like, in everything we do.
Moving away from banks for a moment, we're going to talk a little bit about home equity and a report that was released recently by data analytics provider CoreLogic. It showed that home equity rose 12.3% year over year in the second quarter of 2018, meaning that the average homeowner in the U.S. saw their equity increase by a little bit over $16,000 in one year. Matt, I swear, I knew I felt richer. But now here's the proof.
This, obviously, is average numbers. We're talking about everywhere from California to Northern Virginia and everything in between. With that said, I mean, some geographic regions saw bigger absolute dollar bumps than others. But the bottom line is that as homeowners, this matters.
I'm a homeowner, you're a homeowner. I think it's a conversation worth having. I always think about this home equity, and I wonder how other people view their home equity. Is it a security blanket? Is it an emergency fund? Is it something that you use to travel? I mean, how do you personally look at your home equity today?
Frankel: I mean, I look at it mostly as an emergency fund. It's nice to have if I need it. Home equity is generally a low-cost form of borrowing, in terms of interest rates, because it's backed up by your home. You can generally get a home equity loan or line of credit for less than you could get, say, a personal loan. In that sense, it's a nice emergency fund if you need it.
I don't like to view it as a capital piggy bank as a lot of people do just because, it's your house. You want to build equity. That's half the purpose of being a homeowner, is to eventually build up some equity over time. If you're going to use your home equity, I always suggest doing it on things that are going to enhance the value of your home. My home is only four years old, so we haven't had to do any major renovations yet. But, say, if, in 20 years, I need a new kitchen, that's something I would consider using my home equity for because it's going to enhance the value of my home.
I hope Americans don't start getting into the habit of using their home equity for, say, vacations, or to buy a boat, or making other big purchases like that, as we saw before the financial crisis. That's where it starts to lead to trouble. Yes, you have equity in your home now, but as we saw 10 years ago, it could just as easily go the other way. You could have $100,000 of equity in your home right now, but then your home drops by $100,000 in value. Now you don't have equity. Now you owe money against an asset that isn't worth what it's backing. It can just become dangerous.
So, I'd say it's an emergency fund. It's nice to be there. But be careful when you use it.
Moser: Yeah, there is history on our side here. I know what you mean. We saw that back in 2005. I was working at Bank of America as a loan officer in the early 2000s, I think it was 2000-2002, in that in that general area, where all you had to do is walk into a banking center and tell us that you wanted to refinance, and you were pretty much approved right on the spot, no matter what. We saw that money going toward all sorts of different uses. I tend to agree with you. I look at our home equity and I think, that's a nice emergency fund if we need it. Ultimately, I hope it's a nice tailwind when we decide to perhaps downsize a little bit, once the kids are older and moved out. I definitely would not support tapping our home equity for anything frivolous.
Now, I mean, to your point, enhancing the home, making repairs or additions, I think that makes sense. A point here worth noting, beginning in 2018, the interest on home equity debt is no longer deductible unless it was used to buy, build, or substantially improve your home. It is a little bit of a different scenario today than it was 10-15 years ago. That's probably not the reason people took out that debt, because they knew they could deduct it from their taxes. But it does seem like, at least today, there is less incentive there. It doesn't mean you can deduct everything under the sun.
I think that probably makes the most sense. It's interesting to note, too, that on top of the equity news, average FICO scores -- which are essentially that borrower's report card, that's going to determine what kind of a credit risk you are -- FICO scores are at all-time highs, an average of 704. That's pretty phenomenal. I know my FICO score, it's better than 704, but I consider myself on top of our bills. That means that people are able to borrow. That's worth noting, as well. I do think it's worth noting, the changes on the deductibility of that interest.
Matt, let's go a little bit more toward these start-up banks. Let's move away from the legacies and more toward the future here. You and I, we talk a lot about Square. Square's a company we like a lot. We're both invested in it. Based on what I saw on Twitter last week, it sounds you've done even better on your Square investment than I have, which is just terrific. I think you said you were up about 800% or something at this point?
Frankel: Yeah. I got in when they were trading at about $11.
Frankel: At the time, I didn't see it for what it was. I just noticed the little Square readers popping up everywhere around town and said, "Hey, there's a future in that."
Moser: I think it's very difficult when you see these types of companies to see how far they can go based on what they are at that current small little start-up status. I think for the most part, Square is seen as a payments company, and rightly so. But this interview with CFO Sarah Friar is from a Recode conference a couple of weeks back. We'll tweet the link out to that interview on the Industry Focus Twitter feed.
Matt, you published an article a few days back on fool.com called The Biggest Reasons Square's Stock Could Keep Climbing. It centers around what I think is a bit of a serendipitous product offering for the company that is really starting to pay off, right?
Frankel: Yeah, the Square Cash app. Square Cash just recently surpassed Venmo in terms of total downloads. It's become a very, very popular app. The thing that people need to know is, Square doesn't really make money on it. They have about seven million active users. They're using incentives to get people to use their platform more. They're using an offers bonus program that Square is footing the bill for. They're actually probably losing money on Square Cash right now. But the long-term potential of that is what those customers could be used for. This is where the banking part comes in. Sarah Friar, the CFO, just recently said that anything you can do with a bank, you'll eventually be able to do with the Square Cash app.
The big thing that people have speculated is Square's going to start doing personal loans to cash customers. That would be a very natural transition. They already do business loans through Square Capital. They've already made their intention clear on applying for a banking license. That could be a very natural progression. Things like savings and checking accounts, high yield CDs, even a brokerage platform, are all things that are possible. They have seven million active users, more than 33 million downloads in their ecosystem that they could leverage.
She said that one of the reasons that they feel this way is because people are actually leaving pretty large balances in their Square Cash accounts. They want to help these people put that money to work, use it to their advantage, invest for their future, be able to loan them money if they need to.
Just to put that in perspective, Square has about two million business customers, which is what they're generally known for. They have more than 3.5X the amount of active customers in the Cash app. When we say that they've barely begun to unlock the potential of their business, that's where that comes from. This is millions and millions of people. Even if they got the same adoption rate as square Capital's business loans, this could be a big revenue driver for the company that can make the payment processing business look like small potatoes at some point.
I've said that Square could easily grow into the size of PayPal (NASDAQ:PYPL) or beyond, which would be huge compared to its current price. I think that Square Cash is the future of the company, hands down.
Moser: I think you're right in that comparison to PayPal. If you look at the gross purchase volume that goes through both networks today, Square is still essentially a fraction of PayPal's, yet they're both really tackling that same market, and clearly they're both leading the way. Plenty of room for them to grow. The quote that she mentioned on the call there on that interview that really stood out to me is when she said, "Commerce is a continuum." I think that speaks to, essentially, what you were just talking about there. Square's much more than just a payments company. They're looking to be a part of the consumer's experience from start to finish. The encouraging thing there is that they're using a lot of data to make a lot of really good decisions. I think a lot of great things probably still to come out from this company.
Alright, let's take a look at this week on Twitter. I'm going to go here to @Every90Midwest, who chimed in. He said, "I bought something today at Home Depot using my Amazon Visa card via PayPal. Own all four, feels good." Every90Midwest, that's the way you do it. You have Amazon, Visa, Home Depot, and PayPal all in the same sentence, all in the same portfolio. It doesn't take a genius to realize, if you're holding those four names, they're all four outperforming for you.
What that tweet brought up, though, was a good question from @JeffreyLeaf. He asked, "I bought and appreciate the bucket." He's talking about the war on cash basket that I recommended a little over a year ago -- Square, Visa, MasterCard, and PayPal. He said, "I love that basket just as much as anyone, but why can't Visa circumvent PayPal in this scenario?" It's a really good question, actually. You can think of it a number of different ways. First and foremost, I think it goes to recognizing that the value chain in regard to money moving from point A to point B is anything but simple. If you look at the players in that space, more and more, it becomes a big game of connect the dots to try to figure out every step of the process and how each company plays their little role in that process.
We were talking about earlier, Matt, when it comes to Visa and PayPal, the main reason why Visa can't really circumvent PayPal in this scenario boils down to the core purpose that PayPal serves and what the company was started on anyway, right?
Frankel: Yeah. PayPal is kind of the first mover in what it does. It's not that Visa couldn't do what PayPal does. It's that at this point, it would just be too tough to overtake them. PayPal has gotten very big and very good at what they do. It's not that Visa couldn't develop the technology. Visa is very, very good at what they do. They're perfectly content to let their business grow. Right now, it's growing at about 20% annual rate, just because of the worldwide transition away from cash that we always talk about. They're perfectly happy with that. They don't need to invest billions and billions of dollars to become the next PayPal. They could do it, but there's no good reason to. It wouldn't make very good sense from a business perspective. It would just cost way too much money to do. And even then, it might not be successful.
Moser: Yeah. It really shows you how much of a head start PayPal had on everyone. When they saw, back in the day, how the internet was changing the way everybody did everything, from consuming entertainment to buying things, heck, to going to the doctor at this point, even. To be able to essentially create a new position in the value chain, which basically what PayPal did. You're right, at this point now, they've gotten that network so big and so strong, they've created essentially another position in the value chain. It really would more than likely be a waste of Visa's time to try to invest money in displacing PayPal when they could simply be a partner of PayPal's and continue to benefit from that toll booth that they run so well.
So, I tend to agree. I think that we'll continue to see PayPal, Square, companies like that, will be partnering up more and more with Visa and MasterCard. And I think Visa and MasterCard are going to be really happy to do it. Companies like PayPal and Square, especially because they tap so much into small business, they really do promote a lot of spending that otherwise perhaps would have been transacted in cash years ago.
Let's wrap this week up here. We're going to talk about One to Watch. This is a stock we have on our radar for the week for one reason or another. Matt, I'm going to let you start it off here. What's your One to Watch this week?
Frankel: Everyone knows me as the REIT guy. I'm going to recommend a real estate investment trust known as Digital Realty Trust. They are one of the biggest owner operators of data centers in the world. They just announced a big acquisition of a Brazil-based data center company that made the stock go down a little bit, so I think it's a pretty good time to take a look at it.
They are a great play on the need for data storage and -- it goes along with what we've been talking about -- everything migrating to digital and rising connected devices all over the world. There should be no shortage of demand for data centers going forward.
Digital Realty pays about 4% per year as a dividend and has done an excellent job of increasing that at a double-digit rate over its roughly 15-year history. I really don't see that changing anytime soon. After this little pullback when they announced their acquisition, I think it's a really good time to take another look at the company.
Moser: What's the ticker for Digital Realty?
Frankel: It is DLR.
Moser: I'm gonna actually go with PayPal this week. Really, it was just because I saw at the end of last week the news that they were cutting off Infowars from their network. I tell you, when it rains, it pours. Infowars can't seem to catch a break here, but I think that's probably for a good reason. You're going to have people taking both sides of the coin on this one. Freedom of speech vs. generally just being a good person. I mean, I think Infowars has dug their own grave here. I think it's worth noting, it's free speech, not free speech without consequence. Otherwise, there'd be no libel or slander or any type of litigation in regard to that stuff.
I think at the end of the day, PayPal is not going to be affected by something like this. A lot of people like to think maybe they will be. I'd put my money against that. Just as folks thought Nike's Colin Kaepernick ad was going to cause big problems, these are businesses that do a lot of thinking about these types of decisions before they make them. I think with PayPal, this is ultimately going to be something that ends up a non-issue for them. Certainly, creates a little bit of a headline in the short run, but not anything I think investors need to worry about. At the end of the day, hey, listen, just be a good person, be a nice person. If you do that, everything else seems to work out alright. It's pretty easy to do.
Matt, thanks for joining me this week! Appreciate you coming by!
Frankel: Alright, thanks for having me!
Moser: Yep, we'll see you next week! As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Matt Frankel, I'm Jason Moser. Thanks for listening! We'll see you next week!