There is a lot to dislike about bank stocks these days. Dodd-Frank has hit banks in the fees. That, and weak loan demand, contributed to a 40% drop in the banking industry's pre-provision earnings in the first quarter. The wimpy loan demand has banks relaxing credit standards in what could be the beginning of another race to the bottom. Earnings could take big one-time hits from the cost of settling robosigning charges and repurchasing toxic mortgages. There's so much wiggle room in how banks value loans nowadays that you can't trust the value of assets on their books.

I'm not the only one that doesn't like bank stocks. Short interest -- risky bets that a security's price will fall -- on the Financial Select Sector SPDR Fund ETF recently clocked in at a whopping 22% of shares outstanding. Its top 10 holdings read like a who's who of "too big to fail" TARP recipients (see table).

Security

% of Assets

JPMorgan Chase (NYSE: JPM) 9.44%
Wells Fargo (NYSE: WFC) 7.97%
Berkshire Hathaway B 7.49%
Citigroup (NYSE: C) 6.93%
Bank of America 6.46%
Goldman Sachs 4.08%
American Express 2.67%
US Bancorp 2.58%
MetLife 2.56%
Morgan Stanley 2.10%
Financial Select Sector SPDR Fund Top 10 Total 52.28%

Source: Capital IQ, a division of Standard & Poor's, as of June 8.

Scarier than a big bank
What could be scarier than a bank that's "too big to fail"? A bank that isn't. The Federal Deposit Insurance Corp.'s list of banks that have failed consists mostly of regional and community banks the government is willing to let go. Is it any surprise, then, that short interest on the KBW Regional Banking ETF is a stunning 191%?

Which stocks are short-sellers most worried about? The FDIC doesn't disclose which banks are on its "problem" list of banks at risk of flat-out failing. And, while most of the short interest appears to be targeting the sector through exchange-traded funds, there is picking and choosing among individual banks. For example, the level of short interest as a percentage of shares outstanding on Synovus Financial (NYSE: SNV) is almost five times the level on Regions Financial (NYSE: RF) and more than 10 times the level on Wells Fargo (see table).

Company

Short Interest as a % of Shares Outstanding

Recent Change in Short Interest

Synovus Financial 9.5% Down 11.9%
KeyCorp 3.1% Up 3.2%
Huntington Bancshares (Nasdaq: HBAN) 3.1% Down 17.8%
M&T Bank (NYSE: MTB) 2.8% Down 3.8%
Regions Financial 2.0% Down 14%
Citigroup 1.7% Up 24.6%
PNC Financial Services Group (NYSE: PNC) 1.7% Up 9.7%
SunTrust Banks (NYSE: STI) 1.4% Up 15.9%
Bank of America 1.0% Up 7.5%
JPMorgan Chase 0.9% Up 6.1%
Goldman Sachs 0.9% Up 0.7%
US Bancorp 0.8% Down 3.1%
Morgan Stanley 0.8% Down 3.1%
Wells Fargo 0.7% Up 3.5%

Source: Capital IQ, a division of Standard & Poor's. As of June 8.

Among "too big to fail" banks, troubled Citigroup has by far the largest short interest. What's more, it recently experienced a huge jump up ... perhaps related to Citigroup's reverse stock split on May 9.

Coming up thorns
What is it the short-sellers don't like about banks? The FDIC's latest quarterly report on the banking industry contained plenty of bad news. Net revenue declined more than 3% year over year. It was only the second time net revenue declined in the last 27 years.

Earnings improvement was concentrated among a paltry 1.4% of banks, which grabbed about 85% of the industry's profits. The FDIC's list of "problem" banks -- those at risk of failing -- continued to grow, from 884 to a whopping 888. That's one of every eight U.S. banks.

Foolish takeaway
While there is more to successful investing than watching short interest, shorting a stock is a risky bet. Short-sellers are typically seasoned, savvy investors who do their homework and place real money on the line. If you're considering investing in bank stocks or a financial services sector fund, it pays to see if short interest is in line with your investment thesis. Currently, they're betting against financial stocks and they are generally more negative on regional banks than on "too big to fail" banks.

Bank stocks are hard to stay on top of and you won't want to miss any critical information about your portfolio. To help, The Motley Fool introduced a free My Watchlist feature. You can get up-to-date news and analysis by adding companies to your watchlist now: