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Regional banks had underperformed the bigger, better-known banks last year but it appears that the situation is going to change this year.
Some of the nation’s largest banks like Bank of America (BAC - Analyst Report) and Citigroup (C - Analyst Report) reported lackluster to disappointing results recently, mainly due to higher legal costs and low interest income.
On the other hand, some of the regional players like PNC, Fifth-Third Bank, Comerica, and BB&T have reported much better results, among others resulting from the mortgage refinancing boom and solid loan growth. (Read: 3 Excellent ETFs for Income Investors)
While the banking industry continues to face some serious challenges, resulting from regulatory uncertainty, low interest rates and sluggish loan, it appears that the regional banks are in a better position to deal with these challenges.
Fed’s latest quarterly survey showed that credit standards on loans had eased modestly and the demand for business loans, prime residential mortgages, and auto loans had strengthened but the demand for other types of loans was about unchanged. (Read: Best ETF Strategies for 2013)
It appears that the smaller banks are benefitting from improvement in loan demand and mortgage refinancing boom. Many of these banks reported healthy increase in loans, which was able to offset the decrease in interest margin. On the other hand, loan growth was almost elusive for the bigger banks and the margins continued to shrink.
Capital rules now require big banks to maintain thicker capital cushions than other institutions. While higher capital norms reduce risk, they also reduce profitability. Further the regional banks have very little or no exposure to Europe. Additionally, rise in interest rates and steepening of the yield curve will be beneficial for the regional banks. (Read: 4 Excellent Dividend ETFs)
Further, for smaller banks asset quality has been gradually improving, which will result in provision expenses continuing their downward trend. Many banks have been releasing reserves as a result of decline in the charge-offs, which peaked during 2009.
Smaller banks have simpler business models and focus on local clients. Retail clients as well as small local businesses now trust regional banks more than the bigger banks as they believe that the regional/local banks understand their needs better.
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 79 regional banks and thrifts and rebalances on a quarterly basis.
KRE is currently Zacks #3 (Hold) ETF. It charges the investors 35 basis points in annual expenses and pays out 1.85% yield currently.
PowerShares KBW Regional Banking Portfolio (KBWR - ETF report)
This is a new relatively 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 (3.71%) followed by Texas Capital Bancshares (3.07%) and First Republic Bank (2.78%). Average market cap of its holding is $1.6 billion.
KBWB is ranked #1 (Strong Buy) ETF. It charges the investors 35 basis points in annual expenses while the yield is 1.19% at present.
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 (20.07%), followed by PNC Financial (10.93%). Average market cap for the holdings is $21.22 billion while the maximum market cap is $60.06 billion.
IAT is currently Zacks #3 (Hold) ETF. This is the most expensive ETF of the three with expense ratio at 0.48%, while the yield is currently at 1.82%.
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