Regional banking ETFs have been among the top sector performers the past two weeks as investors take a second look at smaller lenders to profit from rising interest rates and a steeper yield curve.
SPDR S&P Regional Banking ETF (NYSEArca: KRE) is up 2.6% for the trailing month while iShares Core S&P 500 ETF (NYSEArca: IVV) is off 1.9%. KRE shuns the large money-center banks to focus on smaller regional lenders.
Top holdings in the regional bank ETF include Zions Bancorp. (NasdaqGS: ZION), M&T Bank Corp. (NYSE: MTB) and Regions Financial (NYSE: RF).
“Another smaller, less liquid regional banks ETF, iShares Dow Jones US Regional Banks (NYSEArca: IAT), offers similar niche exposure. However, it includes a handful of superregional banks,” says Morningstar analyst Robert Goldsborough. “Also, in contrast to KRE, IAT weights its holdings by market cap, which makes its portfolio top-heavy and gives it a much higher average market cap.”
Regional banks, not surprisingly, follow the fortunes of their local economies and housing markets.
These lenders are also sensitive to the shape of the yield curve.
“A flatter yield curve reduces the spread between the rate at which banks can borrow and lend because they fund most long-term loans through short-term deposits,” Goldsborough writes in a report on the regional bank ETF. “A steepening yield curve tends to have the opposite effect. So, investors in KRE should have a strong risk tolerance and a belief on a banking-sector recovery and a steepening yield curve.”
Margins at regional banks with a high percentage of variable-rate loans stand to benefit from rising rates, Bloomberg News reported.
KRE rose to a fresh multiyear high on Thursday. In fact, the regional bank ETF is at its highest level since the financial crisis.
SPDR S&P Regional Banking ETF
