Reasonably Thinking

Recycling the CYN trade

On Friday afternoon, I shorted 50 shares of CYN at $41.22.  This is a recycled trade from August, but the investment thesis has slightly changed.

This is not financial health story.  I am not shorting CYN based on capital ratios, a speculated dividend cut, or anything to do with management.  I have no gripes in any of these areas.

Shorting CYN is a valuation story.  This is a California economy story.  This is a creditworthiness story.  This is a market is overvalued and going to harm CYN on its way down story.

From the August article, three arguments remain sound.

• The market is overvalued at 1,100.  CYN is defenseless against a market decline.
• Credit problems will hamper earnings.  Oncoming mortgage reset rates (Option-ARM & Alt-A) will be problematic and of lengthy duration.  When loans fail to be repaid, CYN will suffer.
• California is of the four worst states to conduct business (the other three being New York, New Jersey, and Illinois).  The state has severe fiscal woes and rising unemployment.  Last week’s edition of The Economist publicized this in an article, stating that California has unfunded liabilities for retirement programs exceeding $100 billion through the next six years.  An unhealthy economy is sour news for banks operating within it.

Further, on a personal level, I am trying to increase my short exposure to better align myself with my portfolio allocation goals (which I am hoping to publish in early January).

One concern I am aware of is that 24.7% of float is short.  So, there is the potential that other short sellers simultaneously exit their positions, which would temporarily increase the stock price.

Other Reasonably Thinking news:

I still presume my option on SDS will be put to me.  (Though, this is not yet reflected in my account).

Also, I’m drafting an end of year page which should be up in early January.  Stay tuned!

The case for shorting CYN

When taking a position in an individual stock, I like to find as many solid arguments as possible.  This way, I only need one of them to really ring true to capture the move.  Here, I provide my many reasons for shorting City National Bank (CYN).  With CYN, the company has potential pitfalls at the macroeconomic, state, and firm level.

Argument 1, the market is overvalued at 1,000.  When the market falls, CYN will probably fall too.

Argument 2, provisions will drag on earnings.  Mortgage reset rates (Option-ARM & Alt-A) are set to jump again starting in 4Q09.  Though I do not believe it will be as severe as the subprime mess, it will probably be longer, lasting through 1Q12.  In addition, commercial real estate rents are falling.  This puts increased pressure on CYN’s commercial debtors, which ultimately appear as increased provisions on the income statement.  In my opinion, the loan book will definitely continue to worsen, over the short term and long term.  Increasing provisions, in my opinion, will put CYN in the red for 2009.

Argument 3, since I believe CYN will have negative earnings, they will miss management’s forecast (of positive year-end earnings).  A restatement, or flat out miss, lowers expectations about the stock and pushes the stock downward.

Argument 4, California is generally not a desirable place to conduct business.  This is reflected by the facts that the state has severe fiscal woes and rising unemployment.  A poor regional economy will hinder any bank’s performance.  Further, I have also read that the residential delinquency rate (0-90 days late) of homes in California is about 10%; that’s a huge number!  In normal times, a bank, in my view, has residential delinquencies of 2.5-6%.  From another perspective, non-current residential loans (90+ days late and non accruing loans) is at 5% for US Commercial banks (as of 3/31/09).  If debtors aren’t making payments, the bank is in trouble.

Argument 5, I would not rule out a dividend cut.  Now, I am not predicting this to happen imminently, nor have I conducted a thorough cash flow analysis.  Yet, with all the other factors in play, this should be a discussed catalyst.

Execution:  Since I am short CYN, I want to know how much cash cushion I’m working with.  If CYN increases 12.5% (from $40.66 to $45.75), I’d be down $210.  This is within my comfort range and probably where I’d revisit my thesis.  If the thesis holds, I would likely increase my position.  If CYN falls 6.5% (to about $38), I’d be up $100.  I would probably consider taking profits here.  (I prefer to take profits quicker in short and option positions relative to long positions; this is strictly about comfort level).