2 Banks To Short In The Coming Pullback

Includes: BNY, DB
by: David Urban

Since the middle of March the US market has traded sideways while the European markets pulled back. Weak economic data compounded by the out of control wildfire raging in Europe and election risk indicate that the Three Peaks and a Dome a Pattern will likely come to a resolution soon.

These two banks have some risks which are not fully quantified within their stock prices and would be good short candidates through the historically weak summer months.

1. Deutsche Bank (NYSE:DB) - The European financial crisis was supposed to be ring-fenced at Greece but as the crisis now spreads to Spain, the Netherlands, and back to Greece one needs to take a long look at European banks. Deutsche Bank is Germany's largest bank, making it a nice proxy for the European banking sector.

While we may have some idea of the Spanish and Dutch exposure, Greece seems bent on testing the patience of Europe, and Germany in particular once again, we have no idea about prospective losses which comes at a time when the bank is facing lawsuits stemming from the possibility that Deutsche Bank and others manipulated the LIBOR rate.

In addition, the LTRO program has allowed banks to borrow cheap money and recycle back into sovereign debt. The problem is that since the banks have become so interconnected sovereign debt problems funnel back to the banks and then to the counterparty relationships.

The retrenchment continues with subsidiaries being sold off as the asset management subsidiary is sold to Guggenheim Partners and other subsidiaries are sold off globally.

2. Bank of New York (NYSE:BNY) - The Bank of New York has a long a rich history stretching back to the 1700s and was the first corporate stock traded on the NYSE. The bank now is a significant custodian in the financial services industry with more than $25 trillion in custody and administration.

The stock has risen by around 50% from last year's lows but there are some problems which should give investors pause and set the table for a short as the market pulls back.

The first area is triparty repo exposure, a little known area, which the Fed is sending out warnings to major players as risk exposures are hard to quantify. Bank of New York is a major player in this area with 56% of the business. Should the problems in Europe explode there may be more problems emanating from this area. A secondary risk is more players entering the business cutting market share and margins.

There are a number of problems in the Forex area which have contributed to a 21% year over year decline in the first quarter ranging from governmental to additional competition.

The final area is the STARS tax case which ends up being a lose-lose situation for Bank of New York. If they lose the case they will pay a penalty to the IRS, if they win the IRS will rewrite the tax laws to close this loophole.

Disclosure: I am short the broader market.