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Regional banks have been leading the financial sector higher for much of 2013. This space has been a strong player as worries over global growth rose, and investors wanted to focus on the U.S. market for exposure.

Beyond this, regional banks have also been prime beneficiaries from a widening spread between long and short term rates. This has largely been due to expectations of QE tapering which could boost yields on longer dated securities while keeping the short end of the curve subdued (see Time to Bank on Regional Bank ETFs?).

No Taper

While many investors thought that the QE taper would begin in the September meeting, Bernanke and company squashed this idea, choosing instead to keep the $85 billion in monthly QE intact. This led to a big immediate decline in rates, and it helped push down expectations for mid-term Treasury debt as well.

In fact, five year government debt, which was trading around the 1.85% level as late as the fifth of September, has been on a steady decline lately. These notes then plunged from 1.62% to 1.43% immediately following the announcement, before settling just under the 1.50% mark in the first full day after the 'no taper' release (see 3 ETF Winners from the No Taper Shocker).

This decline in medium-term debt levels and rising expectations that we may see either a modest taper at the next Fed meeting, or even another ‘no taper’ announcement, left expectations of a compressed spread pretty high.

Impact and How to Play Going Forward

The combination of this decline in rates along with muted expectations for future tapering had a pretty negative impact on regional bank ETFs in Thursday trading, pushing them down more than the overall market in the time frame. The sluggish trading lately may also be causing investors to question more purchases in this once-soaring space, especially given recent events.

However, the taper is still going to come eventually, and rates have actually already regained some of their momentum. So while rates may be still off of their recent highs, it is pretty reasonable to expect them to rise back to previous levels in the coming weeks.

And when the Fed does inevitably taper, the spread will once again widen, making a regional bank investment a pretty solid play. For this reason, investors looking out at least a few months might consider the recent slump in the space as a decent buying opportunity, and a great way to get in ahead of the eventual taper in a positive way.

While investors can certainly buy up any regional bank stock out in the market, an ETF approach may also be a sound idea. This technique allows investors to play the broad trends in the space without worrying about company specific issues, potentially lowering risk in the process.

For investors intrigued by this idea, we have highlighted some regional bank ETFs below. Any of these could be interesting choices to get in on the solid trend in this corner of the market and buy some well-positioned companies on the dip.

SPDR S&P Regional Banking ETF (KRE - ETF report)

This is the most popular regional banking ETF on the market, with over $2 billion in assets under management. The fund saw extreme volume of about 11.2 million shares—compared to an average of about 2.3 million—for Thursday’s session, in which it slumped by 1.8%.

The ETF holds about 80 stocks in its basket, focusing on small and mid caps for the majority of its exposure. The fund does use an equal weight methodology, so concentration issues are minimal; no single company makes up more than 2.2% of the total assets.

From a longer term performance perspective, KRE has added about 12.4% in the past six months, while its five day return comes in at -0.7% (see all the Top Ranked ETFs here).

iShares U.S. Regional Bank ETF (IAT - ETF report)

Another option for investors seeking regional bank exposure is this iShares fund which has just over half a billion in assets. It also saw a big volume day in Thursday trading, while it lost about 1.5% for the session.

Unlike KRE, this product takes a cap weighted approach so its roughly 60 stock portfolio is quite concentrated in large cap companies. In fact, (USB - Analyst Report) and (PNC - Analyst Report) combine to make up nearly 30% of the total assets in this ETF.

For this fund’s performance, the past five days haven’t been too bad as it has added about 0.2%, while the trailing six months have seen a gain of 12.1%.

PowerShares KBW Regional Banking Portfolio (KBWR - ETF report)

An often overlooked option in the regional banking ETF world is the cheap choice of KBWR. This product has under $40 million in assets under management, but can be more volatile, having lost about 2.2% in the rocky Thursday session.

The ETF holds just 50 stocks in its basket, putting the vast majority of the assets into small caps—another reason for the volatile nature of this fund. It does do a great job from a concentration perspective though, as no single firm makes up more than 3.5% of assets (also see A Steeper Yield Curve Makes These ETFs Winners).

In terms of performance, KBWR has lagged as it has added 11.9% in the past six months, while its five day return stands at -0.5%.

Bottom Line

Regional bank ETFs were extremely strong picks in the beginning of the year, and rose more than the overall market when tapering seemed imminent. They were poised to benefit from a wider spread, and making more off of higher loan rates, thereby increasing profits.

However, the shock move by Bernanke to not taper at all pushed these securities lower, and called into question the investment case for these companies. We believe that this may have created an interesting buying opportunity, as the taper has to come eventually, suggesting a play for the slumping regional banking ETFs could be a great idea for those with a reasonable time horizon, and a belief in an eventual taper of QE.

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