Like other financial services exchange traded funds, the SPDR S&P Regional Banking ETF (NYSEArca: KRE), the largest regional bank ETF, is struggling this year with a year-to-date loss of nearly 15%.
That is the tale of the tape for KRE and other sector ETFs that are positively correlated to rising interest rates. As 10-year Treasury yields have come in as investors have favored safe-haven assets early in the new years, assets and sectors positively levered to higher interest rates have been punished.
Contributing to the weakness in the bank sector, traders may have been unwinding bullish bets in the run-up to the Federal Reserve’s first rate hike in December, reports Stephen Foley for the Financial Times. Investors hoped that higher rates would allow banks to capitalize on wider net interest margin – the difference between deposit rates and lending rates, but the global economic uncertainty has weighed on prospects for a quick Fed rate hike schedule.
While U.S. banks have some exposure to over-leveraged oil companies, the level of exposure to the distress energy industry is not up to the scale of the U.S. housing market that triggered the 2008 run. Nevertheless, market observers are weighing on the oil outlook in the recent earnings season.
KRE’s sensitivity to interest rates is well known. The ETF rose just 2% in 2014 after surging 47% in 2013 when yields spiked. KRE’s holdings have an average beta of +0.44 to moves in the US 10 Year Treasury.
“Bank stocks are also set to increase profits in a rising rate environment, and smaller regional banks that derive a larger percentage of their revenues from loans may fare better than the major banks. The SPDR S&P Regional Banking ETF (NYSEARCA: KRE), launched by SSGA in 2006, aims to reflect the performance of the S&P Regional Banks Select Industry Index, an equal-weighted index exclusively devoted to regional bank stocks that, as with the KIE fund, leans more toward smaller firms. The fund has nearly $3 billion in total assets and an average daily trading volume of roughly $200 million,” according to Investopedia.
A rising interest rate environment will throw a wrench into the financial markets. Nevertheless, bank-related exchange traded funds could weather the storm as financial firms have positioned ahead of the potential rate changes. KRE’s sensitivity to interest rates is well known.
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.
SPDR S&P Regional Banking ETF
