Unbanked Customers Embrace Alternatives

NEW YORK ( TheStreet) -- In the aftermath of the financial crisis, some low-end customers are being pushed out of the traditional banking landscape and into the world of alternative financial services.

Alternative financial services -- or AFS as some industry insiders call it -- has been around for years signified by check cashing stores that charge customers exorbitant fees, payday lenders and even retail layaway programs. Those who are considered underbanked, or even unbanked, include immigrants, low income, teenagers and, of course, those consumers that have been deemed risks by banks.

Retailers including Wal-Mart Stores ( WMT) and Sears ( SHLD) have long had offerings for the underbanked market.

But there is a new crop of companies looking to take advantage of this growing market and they're doing so with reloadable prepaid cards.

According to the Federal Deposit Insurance Corp.'s study of the unbanked and underbanked, which was published in early 2009, roughly 60 million consumers are not receiving financial services through a bank or credit union.

"More people are leaving banks. People are not being underwritten for credit cards, especially at the bottom end. And so the use of alternative financial services has increased significantly in the last few years," says Arjan Schutte, senior advisor at the Center for Financial Services Innovation, a think tank for expanding access of financial services products to underbanked consumers.

"Even though remittances and check cashing volumes are stable as opposed to growing, there has been tremendous growth in payday loans and there's been tremendous growth in more payroll agnostic, general purpose reloadable cards which can be used as a payroll card," Schutte says.

The organization estimates that underbanked consumers in the U.S. are paying $29 billion a year in fees and interest.

"There is multi-billion opportunity to serve this customer by providing more efficient products and services that we believe can also, if structured well, can actually be lower cost," Schutte says.

MasterCard ( MA) and Visa ( V) see opportunity and are investing in the general prepaid space.

"There is an enormous opportunity for growth," says Brad Russell, a spokesman for NetSpend ( NTSP), a provider of reloadable prepaid debit cards and other alternative financial services.

As of September 30, NetSpend had 2.1 million active cards in use, up 24% from a year earlier. In terms of gross dollar volume, spending on NetSpend cards rose by a third to $2.4 billion year over year.

NetSpend, which just went public in October, says in its mission statement that it is solely focused on "developing products and services that help unbanked consumers take the first steps toward a smarter way to spend, save and manage their money."

NetSpend's rival, GreenDot ( GDOT) went public in July.

NetSpend and its competitors probably have 1-2% of the potential market customers, Russell says.

The two successful IPOs of NetSpend and GreenDot "has done a tremendous amount from an industry perspective to validate this industry as large and marketable and not left to fringe alternative financial services," Schutte says.

"We've been around since 1999 but it's really been in the last couple of years that this niche has really picked up steam," he says. "There is a lot of misinformation out there about cost structure and fees and lack of consumer protection. Most of that information is inaccurate."

Consumer advocacy organizations such as the Consumer's Union charge that prepaid cards come with high fees including purchase fee, usage fees, reloading fees, cash withdrawal fees and little protections for consumer.

Two weeks ago, the Consumers Union, along with several other concerned parties, wrote a letter urging the FDIC to create a "safe prepaid card" template, much like what it did for savings accounts.

And while prepaid cards have been exempted from financial reform measures, particularly the controversial Durbin Amendment, which will regulate debit card interchange fees, regulation is a major risk factor for the sector in general, particularly given the Obama Administration's mission to curtail real and perceived consumer abuses in financial services.

Gwenn Bezard, research director at Aite Group says fees for prepaid cards are highly visible, as opposed to hidden fees for bank accounts. At a bank you may get a free checking account, "but the fact is the bank is going to make money somewhere," he says.

NetSpend's Russell portends that reloadable prepaid card is a "safer and more convenient and often times less expensive alternative to alternative financial services."

NetSpend has two primary distribution channels - direct to consumer as well as through nearly 40,000 retailers across the country. Users then have roughly 100,000 locations to add money to their card, he says.

Under the card's protections, customers still get up to $250,000 per depositor in FDIC insurance. There is also limited liability under the Visa and MasterCard marks, Russell says.

Consumers can purchase a card between $3.95 and $9.95, however if ordered directly through NetSpend's website, it's free.

For transactions, users can either pay $1-$2 per transaction or for high volume users, pay a $9.95/month fee. Additionally, once a user adds $500 once to the card, they are automatically entered into the premier tier and pay $5/month, the company says. There are no minimum balances and users can choose which fee level is best for them, depending on the amount of usage.

-- Written by Laurie Kulikowski in New York.

To contact the writer of this article, click here: Laurie Kulikowski.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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