Bank ETFs Get A Boost

January 07, 2022

Bank ETFs roared into the new year, notching high single digit gains in the first few trading days of 2022.

The gains experienced by this specific industry are likely due to the rapid increase in the U.S. 10-year Treasury yield. The benchmark rate closed out 2021 at 1.51% and touched highs of 1.75% by Thursday, Jan. 6.

The banking industry is one area that benefits from a steepening yield curve. In other words, banks tend to do well in an environment where longer-term rates are higher than shorter-term rates due to their ability to generate a higher spread on lending, which makes up the bulk of their revenues.

While short-term rates are often dictated by monetary policy, longer-term rates fluctuate based on investor sentiment surrounding economic growth and inflation. Currently, inflation fears seem to be playing more into the steepening yield curve rather than heightened growth estimates.

Two Targeted Plays

When it comes to targeted bank ETFs, investors have two main options: the Invesco KBW Bank ETF (KBWB) and the First Trust Nasdaq Bank ETF (FTXO). As seen in our ETF Comparison Tool, KBWB holds the lion’s share of the assets, likely due to its longer track record and significantly cheaper expense ratio.

 

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Courtesy of FactSet

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Though these ETFs track different indexes, 20 holdings overlap between the two portfolios. KBWB relies on a modified market-cap-weighted strategy, while FTXO selects holdings by liquidity and weights based on volatility, value and growth factors.

Though performance of the two ETFs has been highly correlated since FTXO’s launch in September 2016, KBWB has outperformed by a cumulative 32.1% since then.

 

 

Broader Take on Space

Another option is the SPDR S&P Bank ETF (KBE), which, at 100 holdings, has a broader take on the space for the same expense ratio as KBWB, at 0.35%.

This ETF tracks an equal-weighted index representing the bank segment of the S&P Total Market Index, which includes asset management and custody banks, smaller regional banks, and thrifts and mortgage finance companies. All but two of KBWB’s holdings are also found within KBE.

Its broader scope and equal-weighting methodology mean that a much smaller percentage of the portfolio is held within the top holdings.

 

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Courtesy of FactSet

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Though these portfolios are more differentiated from one another than KBWB and FTXO, performance has mostly been in lockstep for the trailing two years encompassing the market drawdown, and yield curve flattening and subsequent steepening.

 

 

However, extending the time frame back to KBWB’s launch in November 2011 shows that it has outperformed the equal-weighted KBE by a cumulative 76% since then.

 

 

Looking Ahead

As always, it is important to keep in mind that past performance is no guarantee of future results. While larger, diversified banks and smaller regional banks stand to benefit from the steepening yield curve, the path forward for these ETFs could potentially diverge.

Todd Rosenbluth, head of ETF Research at CFRA, predicts that the big banks will continue to perform better than the smaller cap regional banks.

“Large cap, more diversified banks like Bank of America and Wells Fargo are better positioned to benefit in 2022 from the strength of the global economy and likely higher interest rates,” he said.

He also noted that regional banks, on the other hand, will be more reliant on the growth of loan volumes to drive net interest income and revenue growth.  

Regional Banks Could Get Boost

Research from FactSet supports this view, showing that regional banks within the KBW Nasdaq Regional Bank Index tend to be more dependent on net interest income (the spread between funding costs and asset yields) relative to the large cap banks in the KBW Nasdaq Bank Index. Should regional banks be able to grow loan volumes, the steepening yield curve could be a tail wind for these stocks.

According to FactSet, net interest income accounts for 58% of revenues for the larger banks versus 79% for the regional banks. This means regional banks will have more sensitivity to the steepness of the yield curve.

Regional banks comprise about 75% of KBE’s portfolio.

Investors looking for even greater exposure have several ETFs to choose from that solely focus on the regional bank subindustry, including the Invesco KBW Regional Banking ETF (KBWR), the iShares U.S. Regional Banks ETF (IAT) and the SPDR S&P Regional Banking ETF (KRE).

Contact Jessica Ferringer at [email protected] and follow her on Twitter

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