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Mar 24, 2017

S3 BLACKLIGHT: Top Ten Bank Shorts Gain 6.35% in One Week

Bank stocks, which have been riding a post-presidential election wave since November, took a nosedive this week as short sellers in the top ten shorted bank stocks made a 6.35% net of financing mark to market return from March 15th to March 22nd.

President Trump’s agenda hit a speed bump with the repeal and replacement of Obama-care facing congressional hurdles which led to fears that additional bank friendly tax and regulatory reforms might be delayed. In addition to the political uncertainty in Washington, banks are facing threats to one of their main income streams with auto sales and leases peaking and starting to decelerate. Total auto financing is nearing the $1.2 trillion mark for the first time in history, but in order to reach these lofty heights banks have been forced to skew their sales towards less credit worthy purchasers – one quarter of the $1.2 trillion of auto financing falls in the subprime category.

Bank stocks are starting to trend downwards after a yearlong rally. The rally was based on the growth of corporate after tax profits due to tax reform, Federal Reserve interest rate hikes, domestic industrial growth and job creation. Investors are now beginning to take profits as bank stock prices begin to retreat for the first time in five months.    

Even though total short interest of the top ten bank shorts is down 8.6% in 2017, short sellers have been building their positions since the presidential election. Short interest was up $2.9 billion, or 25%, since the election to the end of 2016, as traders anticipated an eventual stock price reversal from the 23.07% run up which occurred by year end.

Last week short sellers finally made back $879 million of the $3.7 billion of losses they incurred in early 2017 and after the election in 2016. If stock prices continue to move in a downward direction we should see short interest climb even higher.

Instead of shorting each of the bank stocks individually, traders could short any one of 53 financial ETFs. Depending on the ETF, the representation and concentration of the top ten shorted bank stocks can vary significantly. The ETFs in the chart above have over $1 billion in NAV in order to provide trading liquidity and contain at least half of the ten most shorted bank stocks. The XLF, IYG and KBWB ETFs would be the best candidates to short in order to get the most exposure to the top ten bank shorts. 

Although the IYG and KBWB ETFs have a high concentration of top ten shorted bank stocks there is very little short interest in these two ETF’s which means there may be liquidity issues in sourcing shares to borrow to cover short sales. The XLF has almost $3 billion of short interest with less than half of the shares available to borrow being lent so borrow liquidity will not be an issue. XLF’s borrow cost will also not be an issue as it is trading at general collateral levels, the cheapest borrow cost for the easiest to borrow securities.

Want deeper insight into the above analysis?
Contact:  Ihor.Dusaniwsky@S3Partners.net
                  Head of Research, S3 Partners
The information herein (some of which has been obtained from third party sources without verification) is believed by S3 Partners, LLC ('S3 Partners') to be reliable and accurate. Neither S3 Partners nor any of its affiliates makes any representation as to the accuracy or completeness of the information herein or accepts liability arising from its use. Prior to making any decisions based on the information herein, you should determine, without reliance upon S3 Partners, the economic risks and merits, as well as the legal, tax, accounting and investment consequences, of such decision.

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