Apple Pay Is the Latest Reason It Stinks to Be a Traditional Bank

NEW YORK (TheStreet) -- As if banks didn't have enough problems, along comes Apple Pay.  

Apple's (AAPL) new mobile payment system, which the company introduced this week, is expected to be part of a multi-billion dollar industry within the next few years. Although banks are actively working with Apple to adapt to the new technology, it is still a major threat to their conventional payment channels.

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The challenge isn't new, of course.

Apple is just the latest to enter an ever-growing field that includes eBay's (EBAY)  Paypal. Large non-traditional consumer banks such as Capital One Financial (COF) and American Express (AXP) ,  as well as large banks such as JPMorgan Chase (JPM) , Citigroup (C)  and Bank of America (BAC) , are likely to feel the squeeze on their traditional banking services. The question is whether their involvement in the new payment channels will be as lucrative as the old way of doing business. 

Banks are seeing a host of other threats to their core businesses. Retail giant Wal-Mart (WMT) is trying to get into the retail-banking business, Lending Tree (TREE) offers online mortgages and Lending Club is a peer-to-peer lender working on consumer or business loans.

On top of that, banks face handicaps that the new competitors don't, such as growing regulation, higher overhead, capital restrictions and higher tax rates than that of tax-exempt credit unions. All this means that it is a very tough environment for banks.

The most vulnerable financial institutions aren't well diversified, are overly exposed to the retail consumers and have bloated and out-dated branching networks.

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Below is a list of those facing the greatest threat, along with a table of those that may be poised to capitalize on these latest trends:

American Express, though not a traditional bank, is heavily exposed to individual consumers via its credit card division which accounts for all its exposure. With a stock price of $88.41 as of Wednesday, the company has had a year-to-date price depreciation of 2.6% and a whopping 4.6 price to book value, so its shares are more than fully valued compared to other financial institutions.

Analysts' 2015 earnings-per-share estimate of $6.06 would only produce a 3% stock appreciation for the next 12 to 15 months.

Any encroachment by new payment technologies such as Apple Pay that bypass traditional banks "old style" magnetic credit cards will likely have detrimental effects on American Express' revenue and profits. However, this erosion would most likely take more than five years to have any material impact, and the company may partner with these new technologies in the short run to stay viable.

In fact, Apple already announced some major partnerships this week. Still, there are concerns with banks having that much exposure to the consumer finance segment (loans, credit cards or mortgages) without meaningful diversification.

Capital One Financial is another non-traditional bank with some diversified lending through its banking division. However, at 62% of its total loans made to individuals in the form of consumer loans, credit cards or residential mortgages, it leaves them vulnerable to alternative banking threats from non-traditional entrants into this space such as Apple, PayPal and Wal-Mart.

The company only has an 11% credit loan portfolio, which may limit its exposure to the new NFC payment technology. However, it has a 25% mortgage portfolio and will compete with upstarts such as Lending Tree and the initial public offering, Lending Club, among other Internet mortgage offerings. Capital One Financial has enjoyed stock appreciation of 6% this year, and at about $81, has a reasonable 1.05 price to book with a 2015 price target of $101, or a return of 24%, based on 2015 estimated earnings of $7.25 a share.

Others on the list such as Bank of America, Huntington Bank (HBAN) , SunTrust Banks (STI) , U.S. Bank (USB)  and Wells Fargo (WFC)  have large residential mortgage portfolios of more than 30% of total loan exposure, which make them vulnerable to online lenders or those with small functional branch offices and lower overhead/fixed costs. Ally Financial (ALLY)  has its greatest exposure to individual consumer loans at 38% of its loans.

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Although investors should be cautious on the names above, due to certain loan concentrations and valuation concerns, the list below shows banks who have managed to diversify their loan portfolios well:

Bank of New York Mellon (BK) , with just 7% of loan exposure to the individual consumer, a year-to-date return of 12% and a reasonable price to book of 1.20, at a stock price of about $39, merits a closer look. Bank of New York Mellon's loans are primarily to other businesses, and though it does have some exposure to foreign entities, its low non-performing assets (to assets) of 0.14%, which is one-tenth the industry average of 1.40%, indicates that the bank is well managed.

Its 2015 estimated EPS of $2.90 and a price target of $43.50 should produce a tidy return of 11% over the next year.

Comerica (CMA) , M&T Bank (MTB) , Regions Financial (RF) and Zions Bancorp (ZION) have limited their exposure to consumer loans, credit cards and residential mortgages, or have managed to avoid high concentrations that mitigate their vulnerability to the newer retail-banking technologies. However, they still must manage the other threats discussed above with regard to regulation, taxes and other overhead costs.

Although some of these banks are fully valued with minimal price appreciation based on  analysts' earnings forecasts for next year, they may deserve a second look on a pullback. KeyBank (KEY) and Regions Financial might be exceptions, with projected returns of 24% and 32%, respectively, on very reasonable price-to-book values.

At the time of publication, the author was long Citigroup, Bank of America, Wells Fargo and Banco Santander, although positions may change at any time.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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