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Wall Street might finally get the reform it needs. Activist investor Jeff Ubben, who founded the activist hedge fund ValueAct Capital in 2000, revealed a 2% stake in Morgan Stanley (NYSE: MS) earlier this month. 
Many see Morgan Stanley as the first of many big banks that will face activist campaigns that aim to cut costs, improve balance sheets and strengthen returns. The big catalyst is a potential breakup.
Breaking up the big banks is not a new thesis for Wall Street or Washington, where there are a number of politicians calling for the reinstatement of the Glass-Steagall Act.
But Wall Street and Washington aren’t the only things putting pressure on big banks. Silicon Valley took advantage of the financial crisis to disrupt lending with financial technology.
A New Lender In Town
Companies from Silicon Valley started leveraging tech to make everyday transactions more efficient and cheaper, allowing people to use their own money or products to help out others. It part of the peer-to-peer economy trend; peer-to-peer has ultimately reached the banking industry.
Companies like LendingClub (NYSE: LC) and Prosper have managed to steal market share as banks got stingy with loans. Since it was founded in 2006, LendingClub has issued over $20 billion in loans.
The Opportunity
Big banks have been under-earning for years. Even though it’s been over five years since the financial crisis, most of the biggest banks still trade below book value. Bank of America (NYSE: BAC), Morgan Stanley, Goldman Sachs (NYSE: GS) and Citigroup (NYSE: Call have market caps below book value.
Meanwhile, LendingClub trades at over two times book value, even after its stock price has fallen more than 50% in 2016.
One bank that’s separated itself from the rest of the pack is Wells Fargo (NYSE: WFC). This also happens to be Warren Buffett’s big banking bet. His Berkshire Hathaway (NYSE: BRK.A) owns nearly 10% of the bank.
Buffett won’t let Wells Fargo face an activist intervention and will likely fight any government regulation that alludes to a breakup. Recall that Buffett stood his ground when ValueAct showed up at American Express (NYSE: AXP). Eventually, ValueAct sold its stake as Buffett pushed back against management change.
Wells Fargo is one of the bigger banks and yet still has a rather diversified stream of fee-generating businesses. It doesn’t have a volatile trading business, nor does it have a capital-intensive insurance business. Wells Fargo has been one of the biggest underperformers in the big bank universe over the last six months.
An underrated opportunity for Wells Fargo is the ability to grow its higher-margin credit-card portfolio. It could quickly gain exposure to this part of the banking business by purchasing one of the industry leaders. American Express comes to mind, as it’s another major Buffett holding.
The Smaller Play in Lenders
With more risk comes more reward. For now, LendingClub is focused on managing the top-level turnover, but sooner rather than later the focus should turn back to its core business of generating loans.
LendingClub is working through issues that don’t necessarily reveal issues with the P2P economy, nor the P2P lending industry. In truth it was a company-specific issue, and in particular, management issue. Its founder and former CEO, Renaud Laplanche, was in charge of selling loans where conflicts of interest weren’t fully revealed, but he resigned last May.
Back in May, I noted that there was still plenty of opportunities at LendingClub. LendingClub stock is up 23% since then, but there could still be more upside.
So, while the P2P lenders can, and will, continue to disrupt the lending environment, there is an opportunity for big banks to provide value to customers. Wells Fargo looks to be the “safest” bet in the industry. But it’s hard not to be enticed by faster-growing companies like LendingClub, especially when you get the opportunity purchase at a price that’s a third of its IPO price.
The author owns shares of LendingClub.