Look to Financial ETFs as Banks Unleash Their Cash

As banks free up their cash hoards accumulated during the coronavirus pandemic, financial sector-related ETFs could benefit from the increased loan activity.

In the months ahead, banks are expected to let loose billions of dollars in reserves they previously set aside to cover potentially poor loans that still haven’t materialized after a year into the coronavirus pandemic that shut down the U.S. economy, the Wall Street Journal reports.

Back in 2020, banks hoarded cash to build up stockpiles in the event consumers and businesses would default on loans as the coronavirus pandemic effectively halted the U.S. economy. U.S. banks had accumulated $236.6 billion in total reserves as of December, according to the Federal Deposit Insurance Corp., almost double their level from the pre-coronavirus environment.

However, the economy has outperformed many banks’ internal forecasts, alleviating many of their concerns. Some even project that consumers and businesses may have dodged the pandemic’s worst-case financial scenario.

“There are a lot of positive reasons to feel good about the path to recovery,” Citigroup Inc. Chief Financial Officer Mark Mason said at the Credit Suisse financial-services conference last month, adding that the bank will likely cut down its $27.6 billion pile of reserves in the first quarter by more than the $1.5 billion the bank freed up in the fourth quarter.

As banks look to free up cash, analysts have lowered their loan-loss projections since the start of the year and lifted the combined 2021 profit forecast for banks like JPMorgan Chase, Bank of America Corp., Citigroup, and Wells Fargo & Co., by 10%, or $7 billion, according to FactSet data. Analysts even project the four banks to earn $77 billion in 2021, compared to $61 billion last year.

As investors look back into the bank stocks, some may turn to broad financial sector-related ETFs to capture the rebound, including the Financial Select Sector SPDR (NYSEArca: XLF), Fidelity MSCI Financials Index ETF (NYSEArca: FNCL), iShares U.S. Financials ETF (NYSEArca: IYF), and Vanguard Financials ETF (NYSEArca: VFH). The broad financial sector ETFs include hefty tilts toward big banks, but these broad sector plays also include other non-pure bank plays in the financial sector covering capital markets, insurance companies, diversified financial services, and consumer finance, among others.

On the other hand, investors can also turn to more bank-focused ETFs like the iShares U.S. Regional Banks ETF (NYSEArca: IAT), SPDR S&P Regional Banking ETF (NYSEArca: KRE), Invesco KBW Regional Bank Portfolio (NYSEArca: KBWR), and SPDR S&P Bank ETF (NYSEArca: KBE). Potential investors should also note that State Street Global Advisors’ bank-related ETFs follow a more equal-weighted indexing methodology, so their holdings lean toward mid- or smaller-sized companies.

For targeted exposure to the small-sized banking segment, investors can look to options like the First Trust NASDAQ ABA Community Bank Index Fund (NasdaqGM: QABA) and Invesco S&P SmallCap Financials Portfolio (NYSEArca: PSCF).

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