SNAP Inc. (SNAP) short sellers, and their Prime Brokers, have been scrambling this morning to cover an avalanche of stock loan recalls which hit the street today. The recalls were due to beneficial owners having sold stock which were on loan to the street. With over 5 million shares recalled street-wide today, stock loan desks have been sweeping the street for the last blocks of available stocks to borrow to satisfy these lender recalls. Prime Brokers are borrowing stock from lenders who are not recalling shares at the moment, to cover their open recall requests. If there is still enough liquidity in the market Prime Brokers will be able to avoid following through on their client recalls, which would force their hedge funds to begin buying-to-cover and exit their SNAP short trades earlier than anticipated. If stock loan availability dries up, we can expect a significant amount of short covering driving up SNAP’s stock price even further from its recent historical low.
At $1.64 billion, SNAP is the second largest short in the U.S. Application Software sector, just behind Salesforce.com with $2.21 billion in short exposure. SNAP shares shorted has increased by 7% since the stock hit its historical low of $10.55/share on May 29th, and short exposure has increased by a third, or $405 million in less than two weeks.
SNAP short selling had been increasing steadily in the early 2018, topping 125 million shares shorted, up 22%, by February 7th but its first positive earnings report since its IPO rocketed its stock price up 48% and squeezed a quarter of the open shorts out of their positions. Shorts continued to cover their positions, except for a late February Kylie Jenner blip, and shares shorted fell to a year-to-date low of 79.5 million shares, $1.35 billion by late March. As SNAP’s stock price inched lower towards the $14/share level, short selling ebbed and flowed as short sellers kept their SNAP exposure between $1.2 and $1.4 billion. When SNAP’s stock price declined below $11/share short selling picked up in earnest, with share shorted increasing by 29% to 125 million and short exposure climbing 54% to $1.64 billion.
Today’s stock loan recalls will make SNAP short positions much more expensive, even if Prime Brokers do their jobs well and cover the street recalls before they hit their clients, the new high cost of borrowing SNAP shares may drive a handful of shorts out of the trade. SNAP’s stock borrow costs averaged just over 16% fee in 2017 and was down to 1% fee by the end of March 2018. With increased short activity recently, stock borrow rates had been getting more expensive and were in the 5% to 11% fee range by the end of last week. Today’s recall activity forced rates to spike dramatically, with rates hitting as high as 45% and averaging around the 40% level for the day.
SNAP short sellers have been a hardy bunch historically; paying away $165 million in stock borrow financing costs in 2017 to earn a net mark-to-market profit of $192.4 million, +15.72%, for the year. With stock borrow cost much lower in 2018 short sellers have only paid $13.6 million in stock borrow financing costs year-to-date. Shorts were up $163.5 million in mark-to-market profits as of May 29th when SNAP hit its historical low, but since then shorts are down $299.1 million bringing their year-to-date P/L to a net mark-to-market loss of $135.5 million.
Stock borrow rates on existing short positions will increase gradually over the next week, with rates moving into the 10% to 20% fee range tomorrow and nearing the 40% level soon if recalls continue and supply remains tight. SNAP’s stock price will probably not be the reason if a SNAP short squeeze occurs, it will be due to stock loan recalls and rate changes.
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Managing Director Predictive Analytics, S3 Partners, LLC
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