The finance sector has been the earnings leader this year, adding
double-digit returns so far this year. It contributed 19.2% to the
Index earnings year to date, the highest among all sectors.
Expense control, sound balance sheets and fewer credit loss
provisions enabled the U.S. banks to report earnings growth in the
three reported quarters this year. Moreover, loose monetary policy,
a reviving housing market, and an upbeat equity market supported
the banks on their recovery path.
However, in the third quarter, the rise in earnings
notwithstanding, overall growth in the industry was slightly muted
due to lesser mortgage activity and lackluster top-line growth.
Total third-quarter earnings in the finance sector increased 9.9%
on the back of paltry revenue growth of 0.6%. This compares
unfavorably with an earnings climb of 32.5% on 7.9% revenue growth
in the preceding quarter (Read: 3 Financial ETFs to Watch on
Volcker Rule Implementation).
Moreover, the bigger players were plagued by legal settlement
charges. The U.S. Banking industry is still confronting mortgage
related lawsuits. Banks of the likes of Citigroup Inc., Bank of
America, JPMorgan Chase and Royal Bank of Scotland are coming under
increased scrutiny because of these suits.
While the mega banks are hit by huge legal payments, stringent
regulatory requirements, falling trading revenue and a relatively
larger exposure to government bonds that are generating lesser
revenues, the regional banks are clearly stealing the show this
time.
Why Regional Banks
Better asset quality and higher loan growth at the regional banks
are clearly benefiting these banks more, especially when compared
to slower loan growth among the larger players. Hardly any regional
bank has been caught on the wrong foot relating to legal suits.
The regional banks mostly serve local retail consumers and the
small and medium companies. As such, these banks are less affected
by overall banking health and are more tied to the local
markets.
Further, many of the regional banks are seeing a pick-up in
commercial lending, which will partly offset the effect of a
declining mortgage business (Read: Mortgage Finance ETF: A Smart
Bet Now?).
Interest rates are expected to rise in the near future since the
Fed began to taper its bond buying program in its most recent
meeting. In this environment, regional banks will be the
beneficiaries as they pay interest at low, short-term rates and
lend at higher, long-term rates. Higher interest rates may lead to
widening spreads, thereby increasing the profitability of these
banks.
Thus a look at the top ranked regional bank ETF could be a good
idea to capture the surge, especially when using our Zacks ETF
Ranking system.
About the Zacks ETF Rank
The Zacks ETF Rank provides a recommendation for the ETF in the
context of our outlook for the underlying industry, sector, style
box or asset class (Read: Zacks ETF Rank Guide).
Our proprietary methodology also takes into account the risk
preferences of investors. ETFs are ranked on a scale of 1 (Strong
Buy) to 5 (Strong Sell) while they also receive one of three risk
ratings, namely, Low, Medium or High.
The aim of our models is to select the best ETFs within each risk
category. We assign each ETF one of the five ranks within each risk
bucket. Thus, the Zacks ETF Rank reflects the expected return of an
ETF relative to other products with a similar level of risk.
For investors seeking to apply this methodology to their portfolio
in the regional banking space, we have taken a closer look at the
top ranked KRE. This ETF has a Zacks ETF Rank of 1 or ‘Strong Buy’
(see the full list of top ranked ETFs) and is detailed below:
KRE in Focus
Launched in June 2006,
SPDR S&P Regional Banking
ETF (KRE) is one of the most popular regional banking
ETFs, having an asset base of $2.7 billion.
The ETF has outperformed the broader U.S. financial services sector
ETF
Financial Sector SPDR Fund (XLF) by a 12%
margin.
The fund tracks the S&P Regional Banks Select Industry Index
and uses an equal weight methodology. This methodology eliminates
company-specific risk as no single company makes up more than 1.9%
of the asset base.
The ETF holds 81 stocks in its portfolio, wherein small caps occupy
56% while mid caps (24%), large caps (10%) and micro caps (10%)
capture the rest.
Top holdings of the fund include PrivateBancorp Inc. (1.82%), Texas
Capital Bancshares Inc. (1.79%) and PacWest Bancorp (1.79%)
(Read: 3 Insurance ETFs Leading the Financial Sector
Higher).
Style-wise, the fund primarily invests in value stocks, which keep
investors away from excessive volatility. Moreover, a lack of
global exposure makes this ETF less risky compared to other broad
banking ETFs.
In fact, the fund has 97% exposure in North American regional banks
and a small remaining exposure in Latin American banks.
The fund has delivered an outstanding 43% during the last one year
and in the year-to-date time frame.
With improving U.S. economic data and the high probability of
rising rates, this ETF is expected to continue with its solid
performance going into the New Year.
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SPDR-KBW REG BK (KRE): ETF Research Reports
SPDR-FINL SELS (XLF): ETF Research Reports
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