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TheStreet Open House

Litigation Costs, Dark Pools and Other Scandals Crush Global Banks

Stocks in this article: DBUBSBCS

NEW YORK (TheStreet) -- From the bad mortgage loans scandal that engulfed many of the major U.S. big banks like Bank of America (BAC) and Citigroup (C) to the Libor rate fixing scandal that involved Deutsche Bank (DB), Barclays Bank (BCS), Credit Suisse (CS) and BNP Paribas (BNP) to rogue trading at JPMorgan (JPM). Now we have "dark pool" trading scandals, with UBS Bank (UBS), Deutsche Bank and Barclays being investigated by U.S. authorities. These billions in additional litigation costs continue to weigh down the banking sector and stock price performance in 2014.

"Dark pool" trading involves stock or other trading orders that are routed through exchanges but aren't listed on these exchanges until the order is done, thus keeping the public in the dark. Institutional investors such as mutual funds, hedge funds and pensions like them because it's less likely that parts of their large orders will get picked off before they're fully executed. However, potential abuse can occur if a high-frequency trading firm sees the order ahead of time, it could potentially jump in and buy a stock before an investor can, thus raising costs for that investor to purchase that stock.

The latest global banks to be dragged into this mess: UBS, Barclays and Deutsche Bank all are down 5%, 17% and 26%, respectively in 2014 (U.S. stock exchange performance only).

Read More: Microsoft Stock Up, Giant Funds Use High-Frequency Trading Clout

All three banks reported second-quarter 2014 results that met or beat analysts' lowered estimates, but profits and revenues were down from prior-year quarter comparisons. Bank management is said to be cooperating with U.S. investigators, but deny allegation that they obtained an unfair advantage over other investors routing large or high-frequency trades.

A review of the banks' financials show they continue to set aside more money for ongoing litigation expenses. However, this along with weak loan demand and the sluggish European economy that continues to underperform the U.S. economy is what has driven down revenue and profit.

So what is the take away from this underperforming sector -- specifically global banks? How can the investor profit from this?

Nearly half of the top global banks are involved in some type of litigation or fraud, their profits or revenues are down and they have weak global economies. Then there are also the new geopolitical concerns, with the Russian/Ukrainian and Middle East crises in Israel. So is this a bottom and a time to buy or continue looking for opportunities elsewhere?

Here is my take, after having covered global banks for the better part of four years now, things are slowly improving from what they were after the financial crises and global recession 2008 and 2010. The litigation will at some point subside when everyone gets their money and global economies are slowly improving.

At this point, the geopolitical pressures are contained and managed and appear to be localized to the areas mentioned above. Although my global financial strength ratings on UBS, Barclays and Deutsche Bank continue to be rated "weak", capital, liquidity, profitability and loan performance (nonperforming loans) metrics continue to improve from their multi-year lows. It may be a bit premature to invest in these banks, as they are behinds their U.S. peers in performance.

See this Street article on first-quarter 2014 earnings "Got Global? Think Toronto Dominion Bank: Trading Bank Earnings, Part 4" for further insight. Unlike our largest U.S. banks, these global players financial performances are back were our American banks were in 2010-2011.

Read More: $25 Billion Deal and JPMorgan Stumble to Aid of Bronx Homeowner


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