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Anxious market observers and investors can now relax a bit as financial ETFs begin a slow, steady climb back to rosy-cheeked health. Better late than never, right?

Once a sector viewed with a mixture of skepticism and fear, it’s now a sector that many believe presents a great growth opportunity. Why?

  • It’s beaten-down. The financial sector is only around halfway from its peak in April. The most beat-up sectors in recessions have the most room to bounce back in recovery.
  • The sector is attracting more fixed-income investors, especially if the 15% tax rate is extended, something that appears increasingly likely to happen.
  • Analysts at Keefe, Bruyette & Woods, believe in the sector, writes John Spence for MarketWatch. “The U.S. financial services sector is poised to shift toward capital deployment from capital accumulation in 2011,” and the “capital redeployment will focus on increased dividends, share repurchases, and mergers and acquisitions.”
  • Financial companies are benefiting from the rise in long-term interest rates since banks tend to profit more on loans when short-term rates are lower than long-term ones.
  • Federal Reserve data also indicates that bank lending is growing, more notably commercial and industrial loan balances, comments Kathleen Gallagher for Journal Sentinel Online. Regional banks are coming back, expanding loans and even acquiring other banks.

The biggest risk to the nascent comeback is the possibility of prolonged unemployment. The sector is also facing new regulations and capital requirements, and continued weakness in housing prices is a high risk for banks. This tells us that the financial sector’s recovery may not necessarily be a smooth, uninterrupted one.

Some of the top-performing financial ETFs over the last three months include SPDR KBW Bank (NYSEArca: KBE), up 10.3%; SPDR KBW Regional Bank (NYSEArca: KRE), up 7%; and iShares Dow Jones U.S. Broker-Dealers (NYSEArca: IAI), up 10.3%.

Max Chen contributed to this article.

Disclosure: None