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ETF News And Commentary

While the banks have come a long way since the onset of the financial crisis, the industry continues to face some serious challenges, resulting from regulatory uncertainty, low interest rates, sluggish loan growth and sovereign debt crisis.

The bank regulatory landscape is continuously evolving with new laws for almost everything from capital and liquidity standards to derivatives trading rules and debit card fees. Capital rules now require big banks to maintain thicker capital cushions than other institutions. While higher capital norms reduce risk, they also reduce profitability.

Continued low interest rate policy is further eating into banks’ earnings. We may add that in general, low interest rate environment benefits the banks, as they can borrow at very low interest rates and lend at higher interest rates but the current scenario of prolonged low-rates is different, as anemic loan demand and limited investment opportunities hurt the return on assets. Also, the Fed has been aiming to flatten the yield curve, while banks typically benefit from the steeper yield curve.(Also read Avoid Turmoil With the Community Bank ETF)

Meanwhile, balance sheet growth remains elusive as the loan demand continues to be sluggish and margins continue to be thin. While the credit standards have eased compared to extremely tight conditions a couple years back and the banks are now much more willing to lend, there has not been much loan growth except in the areas of commercial and industrial loans.

Fed’s latest quarterly survey showed that credit standards on loans remained almost unchanged in the recent quarter even though there was some improvement in the loan demand. Most banks started to tighten credit again as Europe's debt crisis worsened.

Sovereign debt crisis continues to impact the global financial markets and while most U.S. banks do not have significant exposure to European economies, some larger ones have exposure to their European counterparts, which in turn are vulnerable to the events unfolding in that region.

According to a New York Times article, five large American banks have more than $80 billion of exposure to the so-called PIIGS (Portugal, Italy, Ireland, Greece and Spain), the riskiest countries within the Eurozone. Of this exposure, about $30 billion is hedged by credit default swaps and while as things stands now, these banks may not actually need to use the credit default swaps (except for Greece), but in the event of an implosion, those hedges may turn out to be imperfect.

As the industry slowly moves towards recovery, there are also some positives to look at. For most banks asset quality has been gradually improving, which will result in the provision expenses continuing their downward trend. Many banks have been releasing reserves as a result of a decline in the charge-offs, which peaked during 2009. (See Canada Equity ETFs Worth A Look for a play on Canadian banks).

Better capitalization levels and increased awareness for risk management, resulting from the regulatory actions are strong positives, even though these have increased costs and uncertainly in the near term.

Among the various sub-groups within the banking industry, the big money center banks are most exposed to the higher regulatory costs and sovereign debt crisis. Some of the smaller regional banks are currently  in  a  much  better  shape  with  decent  loan  growth  and  cleaner balance  sheets. Most regional banks are not exposed to the problems in the euro-zone or massive mortgage lawsuits in the US. Further, some of the regional banks may benefit from the asset sales by the big banks. Regional banks also tend to do less trading and investment banking business, which are weak areas for revenue growth in the current scenario.

We suggest that the investors should look at the following three regional bank ETFs to gain exposure to this sub-group.  

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

This ETF provides exposure to the regional banking segment of the U.S. banking industry by tracking the S&P Regional Banks Select Industry Index. The Index equally weighs its holding of 73 regional banks and thrifts and rebalances on a quarterly basis. The fund was earlier following the KBW Regional Banking Index and started following S&P Regional Banks Index (inception-September 2011) after October 2011.

PowerShares KBW Regional Banking Portfolio (KBWR)

This is a new fund, created in November 2011. It currently holds 50 companies and follows the KBW Regional Banking Index,  which is an equal weighted float-adjusted market capitalization index. Susquehanna Bancshares Inc is the heaviest weighted stock in the index (3.09%) followed by CVB Financial (2.96%) and SVB Financial Group (2.78%). Average market cap of its holdings is $1.5 billion.

iShares Dow Jones U.S. Regional Banks Index Fund (IAT - ETF report)

Being market cap weighted, this ETF is top heavy, with highest weighting to US Bancorp (21.07%), followed by PNC Financial (12.21%). Average market cap for the holdings is $18.87 billion while the maximum market cap is $51.62 billion. This is the most expensive ETF of the three with the expense ratio at 0.47%

 

KRE

KBWR

IAT

Total Assets ($)

987.34 million

86.6 million

95.2 million

Expense Ratio

0.35%

0.35%

0.47%

Number of holdings

73

50

62

Volume

445,000

33,000

185,000

 

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