What Regional Bank ETFs Need

Regional bank exchange traded funds, including the SPDR S&P Regional Banking ETF (NYSEArca: KRE), have been on a torrid pace in recent months.

KRE, the largest regional bank ETF, is higher by nearly 30% over the past quarter and while a run like that may prompt some investors to be cautious, there are reasons to believe to regional banks can keep their momentum.

Predictably, much of the bull case for regional banks depends on the Federal Reserve and interest rates. With a steepening yield curve or wider spread between short- and long-term Treasuries, banks could experience improved net interest margins or improved profitability as the firms borrow short and lend long. Additionally, the Fed is hoping to raise interest rates as many as three times this year, an effort that could further support KRE and friends.

Higher interest rates would help widen the difference between what banks charge on loans and pay on deposits, which would boost earnings for the financial sector. Regional banks are among the stocks most positively correlated to rising interest rates because higher rates improve net interest margins.

Few industry ETFs are as positively correlated to rising Treasury yields as is KRE, the dominant name among regional bank ETFs.

Goldman Sachs’ Ryan Nash “admits that on a historical basis, bank stocks look pricey, he sees rising rates and less regulation creating an environment where the market values banks on “normalized earnings,” which would help drive the stocks 15% to 25% higher, in Nash’s estimation,” reports Teresa Rivas for Barron’s.

Politics are also boosting bank stocks. President-elect Donald Trump’s official transition website stated that the “financial Services Policy Implementation team will be working to dismantle the Dodd-Frank Act,” which was signed into law by President Barack Obama in 2010 to obviate another financial downturn. The law increased the burden of banks to safe guard against another meltdown event and forced many to greatly reduce exposure to riskier assets, which have also dragged on the financial sector’s bottom line.

If the government does decide to roll back some of the policies under Dodd-Frank, the smaller bank segment may enjoy a quicker recovery. Potential investors seeking to capitalize on the windfall may consider a number of ETFs that target smaller banks.

Goldman’s top picks among regional bank stocks include Comerica (NYSE: CMA), Regions Financial (NYSE: RF) and Zions Bancorp (NASDAQ: ZION), according to Barron’s.

For more information on the banking sector, visit our financial category.

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