Litigation Costs, Dark Pools and Other Scandals Crush Global Banks

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).

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.


As things improve further in 2014, I would be a buyer of the largest and most beaten down names such as Deutsche Bank, since it is the second-largest European bank (by asset size) and the largest bank in Germany. This bank is near its 52-week low and almost 40% off its 52-week high (U.S. stock exchange). The banks indicated in its last earnings report in July that although net profits were down 29% from the prior year, due to higher taxes, litigation expenses, lower revenues from a weak economy, pretax profits were actually up 16%, due to core business improvement in corporate banking and securities.

Full-year revenue is actually forecasted to improve by 3% in 2015 with earnings per share growth of 40% during the same period. With an average estimated 2015 EPS of $3.33 and a forward multiple of 14 times, the 12-month price target for this stock is $46.62, or a 31% premium from current levels.

Additionally, Deutsche Bank currently trades at a less than half of book value at 49%. This is clearly a value play based on the fact that the 140-year-old bank, with 45% of its stock held by institutional ownership, is not going anywhere and will find its legs under them with management doing the right things to get healthy.

At the time of publication the author was long Citigroup and Bank of America, although positions may change at any time.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

TheStreet Ratings team rates U S BANCORP as a Buy with a ratings score of A-. TheStreet Ratings Team has this to say about their recommendation:

"We rate U S BANCORP (USB) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its revenue growth, increase in stock price during the past year, increase in net income, growth in earnings per share and expanding profit margins. We feel these strengths outweigh the fact that the company has had somewhat disappointing return on equity."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • USB's revenue growth has slightly outpaced the industry average of 4.6%. Since the same quarter one year prior, revenues slightly increased by 3.3%. This growth in revenue appears to have trickled down to the company's bottom line, improving the earnings per share.
  • The stock has risen over the past year as investors have generally rewarded the company for its earnings growth and other positive factors like the ones we have cited in this report. Turning our attention to the future direction of the stock, it goes without saying that even the best stocks can fall in an overall down market. However, in any other environment, this stock still has good upside potential despite the fact that it has already risen in the past year.
  • The net income growth from the same quarter one year ago has exceeded that of the S&P 500 and the Commercial Banks industry average. The net income increased by 0.7% when compared to the same quarter one year prior, going from $1,484.00 million to $1,495.00 million.
  • U S BANCORP's earnings per share improvement from the most recent quarter was slightly positive. The company has demonstrated a pattern of positive earnings per share growth over the past two years. We feel that this trend should continue. During the past fiscal year, U S BANCORP increased its bottom line by earning $3.01 versus $2.84 in the prior year. This year, the market expects an improvement in earnings ($3.10 versus $3.01).
  • The gross profit margin for U S BANCORP is currently very high, coming in at 87.58%. It has increased from the same quarter the previous year. Regardless of the strong results of the gross profit margin, the net profit margin of 27.22% trails the industry average.

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