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As Large Banks Slow, Small-Cap Financial ETFs Could Lead

Wall Street banks are stumbling but smaller regional and community banks, along with related exchange traded funds, could pick up the pace.

For example, the First Trust NASDAQ ABA Community Bank Index Fund (QABA) , PowerShares S&P SmallCap Financials Portfolio (PSCF) and PowerShares KBW Regional Bank Portfolio (KBWR) target smaller companies in the financial space. QABA market-cap weights include small-cap 36.1% and micro-cap 38.1%. PSCF holds small-cap 69.9% and micro-cap 27.9%. KBWR includes small-cap 67.5% and micro-cap 13.8%.

The U.S. banking industry recorded its first annual profit drop in 2014, the industry’s first decline in five years, with banks’ net income dipping about 1% year-over-year as seven of the 10 largest banks posted lower earnings, reports Victoria McGrane for the Wall Street Journal.

The Federal Deposit Insurance Corp. pointed to lower mortgage sales, securitization and servicing, along with increased litigation expenses, as contributing factors to the yearly drop in earnings.

While the largest banks in the sector dragged down the industry as a group, the the vast majority of the country’s 6,509 banks reported higher earnings for 2014.

“The banking industry continued to improve at the end of the year,” FDIC Chairman Martin Gruenberg said, noting that community banks did particularly well, with earnings up 28% over the fourth quarter year-over-year.

The FDIC also stated that the list of so-alled problem banks dipped below 300 for the first time since 2008 to 291 at the end of 2014.

Smaller banks, notably community banks, have suffered as sweeping regulations under the Dodd–Frank Wall Street Reform and Consumer Protection Act pressure profits. [Dodd-Frank is a Pain for This ETF]

However, the smaller banks are pressuring regulators to relax rules that were meant for larger banks. [Small Bank, Financial ETFs Could Capitalize on Looser Regulations]

Additionally, investors who want to target the small-cap category in the financial space but still want some steady exposure to slightly larger companies can also consider equal-weight index-based ETFs as well. For example, the SPDR S&P Bank ETF (KBE) includes a 7.8% tilt toward mega-caps, 6.4% to large-caps, 37.9% to mid-caps and 47.2% to small-caps, and the SPDR S&P Regional Banking ETF (KRE) leans more toward small-caps at 53.2%, along with mid-caps 23.6%, micro-caps 17.0% and large-caps 4.2%.

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