Recent weakness in financial services stocks has not skipped over shares of regional banks, but the group’s slack performance as of late could prove to be a buying opportunity for patient investors.

An improving U.S. economy could foster increased borrowing and financing by businesses, large and small, across the U.S. while benign mortgage rates could also provide a lift to the mortgage lending operations of regional banks.

“Commercial and industrial lending and mortgage finance are two primary businesses of regional banks. As the economy grows, businesses increase their borrowing to finance investments and individual consumers borrow to purchase houses. The fundamentals of regional banks may continue to benefit from accelerating US economic growth and rising rates,” said State Street Vice President and Head of Research David Mazza to ETF Trends.

The SPDR S&P Regional Banking ETF (NYSEArca: KRE) last year proved its utility in a rising interest rate environment, surging almost 48% as 10-year Treasury yields spiked. ETFs such as KRE benefit as rates rise because investors believe higher interest rates will lead to increased net interest margin for regional banks. [Don’t Forget This ETF as Rates Rise]

“The stocks in KRE have an average beta of +0.44 to moves in the US 10 Year Treasury, meaning that KRE’s holdings have increased 0.44% on average for every 1.00% move in the 10 Year. As the yield curve rises and the Fed gradually ends quantitative easing, KRE may continue to benefit,” said Mazza.

Ten-year yields have fallen 10% this year, which has weighed on KRE and rival funds a bit. However, interest rates are only part of the story when it comes to bull case for KRE.

Heartened by the results of the Federal Reserve’s stress tests and the annual Comprehensive Capital Analysis and Review (CCAR), investors are devoting cash to financial services ETFs. KRE has pulled in $146.5 million in assets since the start of March as investors anticipated the ETF being a beneficiary of the Fed permitting banks to boost dividends and share buyback programs. [Bank ETFs Waiting on Higher Interest Rates]

Just this week, two KRE holdings – Cullen Frost Bankers (NYSE: CFR) and Regions Financial (NYSE: RF) – boosted payouts.

“With the exception of one bank, all banks within KRE passed the Fed’s recent stress testing exercise, which means that instead of raising more capital to meet regulatory requirements, they can use more of their capital for dividends, share repurchases and investment into their businesses. Strong capital levels help ensure that banks have the ability to lend to households and businesses and to continue to meet their financial obligations,” said Mazza. [Zions Not an Issue for These ETFs]

KRE’s annual dividend has averaged 51.3 cents per share over the past three years, up about 50% from ETF’s 2010 payout, according to State Street data.

SPDR S&P Regional Banking ETF


Tom Lydon’s clients own shares of KRE.

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