Regional Bank ETFs Face Off On Rate Hike Buzz

Includes: IAT, KRE
by: Zacks Funds

The financial sector took the center stage after the Fed kept the short-term interest rates steady in its latest meeting this month, after raising it in December for the first time in nearly a decade. The central bank also took a cautious stance on this year's rate hike trail by dialing back its projection to two lift-offs from the four hikes that were previously expected.

As the rates are likely to remain low for longer than expected, financials stocks and ETFs have turned up as the major losers. In particular, regional banks are the worst hit, as these banks seek to borrow money at short-term rates and lend at long-term rates. Now, if short-term rates do not rise and long-term rates fall, the banks will earn less on lending and pay more on deposits, thereby leading to a tighter spread. This would restrict net margins and put pressure on banks' profits.

However, comments from Fed officials last week point to a hawkish stance. St. Louis Fed President James Bullard hinted that a rate hike could come in April or June, given that the U.S. economy is resilient and strong enough to handle higher rates. San Francisco Fed President John Williams and Atlanta Fed President Dennis Lockhart expect an interest rate hike as soon as April. Meanwhile, Richmond Fed President Jeffrey Lacker believes inflation is moving higher and is on track to meet the Fed target of 2%.

Is a Rate Hike Actually in the Cards for April?

Given the slew of upbeat economic data lately, it seems a rate hike might come in the April meeting. This is because the economy is growing on a modest path with the stronger-than-expected final Q4 2015 GDP reading. The economy expanded at rate of 1.4%, much higher than the second estimate of 1%. Personal consumption also rose 2.4% instead of the 2% gain reported earlier.

Further, unemployment dropped to an eight-year low of 4.9% and inflation climbed 2.3% in the 12 months through February, marking the biggest increase in more than three years, following the 2.2% increase in January. Apart from these, cheap fuel will continue to lift consumers' spending power, thereby boosting economic growth. Notably, gas price has fallen by 46 cents from the year-ago period to an average of $1.96 per gallon, which has resulted in about $1,000 more to spend at each household.

Given the heightened uncertainty surrounding the Fed policy, regional bank ETFs have been in focus lately. In particular, the two most popular ETFs - the SPDR S&P Regional Banking ETF (NYSEARCA:KRE) and the iShares U.S. Regional Banks ETF (NYSEARCA:IAT) - shed 0.4% and 0.2%, respectively, over the past five days.

Being introduced in 2006, both funds have a Zacks ETF Rank of 2 or "Buy" rating with a High risk outlook. While the duo might appear similar at first glance, there are a number of key differences between the two that are detailed below (see all the Financial ETFs here):


This is one of largest and the most popular ETFs in the banking space, with AUM of nearly $1.9 billion and average daily volume of more than 6 million shares. The product follows the S&P Regional Banks Select Industry Index, charging investors 35 basis points a year in fees. Holding 101 securities in its basket, the fund is widely spread out across each security, with none holding more than 2.7%. Zions Bancorporation (NASDAQ:ZION), CIT Group (NYSE:CIT) and M&T Bank Corporation (NYSE:MTB) occupy the top three positions in the basket.

The product has a certain tilt toward small cap stocks, as these account for 57% of the portfolio, followed by mid caps (34%) and large caps (8%). The fund has gained about 9.5% in the year-to-date time frame.


This ETF offers exposure to 54 regional bank stocks by tracking the Dow Jones U.S. Select Regional Banks Index. U.S. Bancorp (NYSE:USB) and PNC Financial Services (NYSE:PNC) take the largest share with a combined 29.6% of assets, while other firms hold no more than 7.14% share. The fund has a nice mix of all cap securities, with 42% allocated to large caps, 33% to mid caps and the rest to small caps.

The fund has amassed $416.9 million in its asset base and sees good volume of 303,000 shares a day. It charges 44 bps in annual fees and is down 8.7% so far this year.

The following table summarizes the similarities and dissimilarities between the two regional bank ETFs:

Inception Date 06/09/2006 05/01/2006
Index S&P Regional Banks Select Industry Index Dow Jones U.S. Select Regional Banks Index
AUM (in millions) $1,988.3 $416.9
No. of Holdings 101 54
% of assets in Top 10 Holdings 26.86% 61.29%
Market Cap Exposure Small All
Expense Ratio 0.35% 0.44%
Average Daily Volume (as per xtf) 6,296,940 303,180
YTD Return (as of March 25) -9.52% -8.70%
1-Year Return (as of March 25) -4.39% -5.90%
Click to enlarge

To sum up, KRE and IAT track different indices and hold different sets of stocks in their top 10 holdings, with a larger concentration on iShares product. Given a higher concentration risk, iShares product underperformed the State Street counterpart by 1.51% over the trailing one-year period. Further, IAT is expensive by 9 bps and has a relatively higher bid/ask spread, thereby increasing the total cost of trading.

Investors should note that KRE focuses on small cap stocks, while IAT offers a diversified exposure to all caps, suggesting their varied preferences.

Original Post