New First Trust Community Bank Fund Could Be a Huge Hit

First Trust Advisors has more than 30 exchange-traded vehicles in the U.S. Neither the sector funds nor the style funds, most of which track AlphaDEX indexes, have been able to garner significant investor interest.

Yet don't write off First Trust altogether. Not only do they have every intention of participating in the ETF revolution, they may finally be starting to hit their stride.

First Trust Revere Natural Gas (FCG) is the go-to natural gas company ETF with approx $70 million in assets. Other natural gas ETFs/ETNs deal with the commodity itself. Meanwhile, First Trust Global Wind Energy (FAN) boasts $90 million in assets and has the distinction of being the "first" wind ETF.

Even if First Trust has not been able to put together a blockbuster vehicle with more than $100 million in assets so far, there appears to be hope on the horizon. In particular, First Trust is serving up a community bank fund for the financial sector... one that is clearly distinguishable from so-called "regional banking."

The First Trust Nasdaq ABA Community Bank Fund (QABA) is expected to launch on July 1. And indeed, this one may provide something that's relatively stable in a financial segment that's anything but sanguine.

Keep in mind, the U.S. already has the streetTracks KBW Bank Fund (KBE), stuffed with mega-banks like B of A and Chase. Then there's the street-Tracks KBW Regional Bank Fund (KRE), chock-filled with regional giants like Hudson City and City National.

What First Trust Nasdaq ABA Community Bank Fund (QABA) is attempting to bring to the table are true blue, low-risk "locals." The upside performance would be steadier and somewhat limited, but the downside volatility would be kept in check by the conservative nature of local enterprises.

What may make QABA even more attractive is its ability to weed out trouble-makers from the get-go. In the paperwork that First Trust recently filed with the SEC, none of the 50 largest banks are permitted for inclusion. What's more, any bank that has been categorized as having "credit-card specialization" would be excluded from the index. (In other words, if another shoe in the credit crisis drops, community banks in this index will be reasonably insulated.)

There are 8000 community banks in the country. Many of them provide dividends. And many of them always adhered to rigid lending criteria. It follows that First Trust Nasdaq ABA Community Bank Fund (QABA) may give First Trust the blockbuster ETF it craves.

Full Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. The company may hold positions in the ETFs, mutual funds and/or index funds mentioned above.

Comments

[GLB123:]

Once you get below the Regional Banks in terms of size and sophistication, there are literally hundreds of straight forward, simple community banks that I like to characterize as "Margin Machines".

The bottom line on these banks is not derived from trading derivatives, highly leveraged investments, or creative underwriting and securitization or for that matter, credit card portfolios or sub prime lending. That's right, for the most part these banks simply fund themselves with local deposits, borrow a bit from the FRB or the FHLB, and make loans to folks they know in their own backyards.

That's not to say that this formula is not rife with pitfalls, but it is a formula that can work beautifully if credit risks are managed well. That's a big "IF" but in the wake of the sub-prime crisis, credit risk management should have every banker's full attention by now.

And with interest rates at historic lows at the short end and a historically steep yield curve, what better business to be in other than community banking? Well, of course there are the regulators to deal with...but that is another story.

Admittedly, we are all in the process of discovering the new "Normal" in business and in the markets. There is no "business as usual" and the old "rules of thumb" for bankers and others have been brutally severed at the first knuckle. Those who persist in relying on the old rules will suffer a similar fate.

That being said, in all markets, the biggest most aggressive players set the pricing hurdles for the competition. Going into this crisis back in 2007, the FDIC reported that bank margins had been on an 18 yr tightening trend that had reduced margins to 18 year and historic lows as more sophisticated players who could leverage and lay off securitized risks (big banks and hedge funds) drove pricing spreads to extremes. The banks that survived, had to learn to become more efficient to compete. some didn't.

With the demise, or nearly so, of most of these leveraged players, and with the interest rate markets that are in place and will remain in place for probably another 18 months, it's prime time to be a community bank or at least to invest in community banks.

Of course there are banks to avoid. My biggest single concern is commercial real estate exposure. And, of course, there may be TARP issues to deal with. But, if you take the time to dig through the balance sheets and call reports for these banks you should be able to ferret out the winners. They won't be rocket ships, but for the most part these banks have been reduced to below book levels because of the contagion from the big boys (money center banks) and the complete lending paralysis of most of the management teams and boards in the banking sector.

So, my thesis is and has been that many of these banks that are now trading below book, should start posting improved if not record margins and appropriate earnings. There will be fall out for sure and mergers and acquisitions of course. Remember, before this mess a well run community bank traded north of 2 times book. I can show you 100 well run banks trading at less than 60 cents on the dollar. But I trust that the folks at First Trust can figure this out too.

Jun 28 10:34 AM