Bank ETFs Buoyant as Market Wait on Higher Rates

ETF Trends

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 exchange traded funds.

“ETFs dedicated to Financial stocks had $1.5 billion of inflows last month,” said Nicholas Colas, chief market strategist at ConvergEx Group, a global brokerage company based in New York, in a note out Wednesday. [Sluggish Q1 ETF Flows]

Investors plunked money into ETFs such as the Financial Select Sector SPDR (XLF) , the largest U.S. sector ETF, and the Vanguard Financials ETF (VFH) , despite the Fed’s rejection of Citigroup’s (NYSE: C) plans to return more capital to shareholders via increased buybacks and dividends. Citi is a top-10 holding in XLF, VFH and rival bank ETFs, though XLF and VFH are each up more than 4% in the past month, indicating investors are comfortable looking past single-stock issues while betting on further upside for the financial services sector. [Big Day for Bank Dividends, ETFs]

XLF and ETFs such as the SPDR S&P Bank ETF (KBE) and the SPDR S&P Regional Banking ETF (KRE) did see some outflows late last month after Fed Chair Janet Yellen hinted interest rates could rise sooner than some investors previously expected. However, higher rates could prove to beneficial to some bank ETFs.

“Higher rates could relieve bankers whose profits have been squeezed by a revenue slump and rising costs. A yield curve plots interest rates over different lengths of time, so a steeper curve creates more of a spread or profit margin for banks between what they pay for short-term deposits and the longer-term yields they can earn on lending and investments,” report Elizabeth Dexheimer and Christopher Condon for Bloomberg.

Although Zions Bancorp (ZION), a constituent in many regional bank ETFs, was the one failure in the Fed’s stress tests of the 30 largest U.S. banks, regional banks are seen as benefiting from higher interest rates because those higher rates could lift net interest margins for holdings of KRE, KBE and rival ETFs.

KBE and the iShares U.S. Regional Banks ETF (IAT) are up an average of 6.3% in the past month . Several of IAT’s top-10 holdings have either announced or expected to announce substantial dividend increases. On a percentage basis, the average dividend hike from SunTrust (STI), Regions Financial (RF) and Keycorp (KEY) is over 61%. Those three banks combine for about 12.4% of IAT’s weight. [Even WIth Citi, Bank ETF Dividend News is Pretty Good]

Financial Select Sector SPDR

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