Q1 Earnings Trend Spells Trouble For Bank ETFs

|
Includes: IAT, KBE, KBWB, KRE
by: Zacks Funds

The financial sector has been on a rough ride since the start of the year even though the broader market sentiments have shown recovery. Most of the pain came from the banking sector, which had a worst start to the year since the financial crisis in 2007-2008, as lower interest rates continued to restrict profitability by shrinking the interest rate spread.

This is because 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, banks will earn less on lending and pay more on deposits, thereby leading to a tighter spread. Additionally, concerns about slow growth in China and the impact of persistently low oil prices on the energy sector have put pressure on investment banking and trading activities as well as loan growth.

According to Dealogic, global investment banking revenues (fees paid for advice on mergers and acquisitions, debt and equity underwriting and syndicated loans) plunged 36% year over year in the first quarter to $12.8 billion. This represents the lowest quarterly number since the height of the financial crisis. The continued market turmoil has pushed down trading activities across the globe with banks witnessing a drop of as much as 56% in their trading businesses.

Further, banks that are highly exposed to the energy sector have increased their loan reserves due to a prolonged decline in crude oil prices. The higher provisioning to cover the bad loans of the energy companies are weighing on the overall banking earnings picture and could result in deteriorating credit quality.

Given the spiral of woes, analysts expect an average decline of 20% in earnings from the six largest U.S. banks, according to Reuters. In particular, Goldman Sachs (NYSE:GS) is expected to post the largest decline of 54.2% when it releases its results before the market opens on April 19, as per the Zacks Estimate. This is followed by expected earnings decline of 41.68% for Morgan Stanley (NYSE:MS), 31.43% for Citigroup (NYSE:C), 18.52% for Bank of America (NYSE:BAC), 13.29% for JPMorgan (NYSE:JPM) and 5.45% for Wells Fargo (NYSE:WFC) when they report in the coming days.

Further, these banks have an unfavorable Zacks Rank of #4 (Sell) or #5 (Strong Sell) with VGM Score of D or F, suggesting that they will underperform the market when the results are released.

Moreover, the downside in this corner can be confirmed by the Zacks Industry Rank, as five out of seven banking industries actually have a negative rank in the bottom 40% at the time of writing. All these indicate significant weakness in the broad financial sector given that the banks are the major contributors to its growth (see: all the Financial ETFs here).

As a result, investors should avoid bank ETFs heading into the earnings season. Below, we take a closer look at four bank ETFs that have lost in double digits so far this year. Though these funds might have a Zacks ETF Rank of 3 or 'Hold' rating, the weakness is expected to continue given the bearish earnings outlook.

PowerShares KBW Bank Fund (NASDAQ:KBWB)

This fund provides exposure to 24 stocks by tracking the KBW Nasdaq Bank Index. It is moderately concentrated across various components with each holding no more than 8.05% share. Though banks account for 84% share, consumer finance and investment companies also take minor allocations in the basket. The fund has amassed $297 million and trades in solid volumes of 387,000 shares per day on average. Expense ratio came in at 0.35%. The ETF has shed 13.6% in the year-to-date time frame.

SPDR S&P Bank ETF (NYSEARCA:KBE)

This fund tracks the S&P Banks Select Industry Index and has an AUM of $2.2 billion. Volume is heavy as it exchanges nearly 3 million shares a day while the expense ratio is 0.35%. The product holds a diversified basket of 64 stocks with none holding more than 2.18% of total assets. From a sector look, about three-fourths of the portfolio is allotted to regional banks while diversified banks, thrifts & mortgage finance, asset management & custody banks and other diversified financial services take the remainder. The fund has lost about 12% so far this year.

SPDR S&P Regional Banking ETF (NYSEARCA:KRE)

With AUM of nearly $1.7 billion and average daily volume of around 6.3 million shares, this product follows the S&P Regional Banks Select Industry Index, charging investors 35 bps a year in fees. Holding 100 securities in its basket, the fund is widely spread out across each security, with none holding more than 2.77% of assets. The fund is down 11.6% in the year-to-date time frame.

iShares U.S. Regional Banks ETF (NYSEARCA:IAT)

This ETF offers exposure to 54 regional bank stocks by tracking the Dow Jones U.S. Select Regional Banks Index. The top two firms - U.S. Bancorp (NYSE:USB) and PNC Financial Services (NYSE:PNC) - dominate the fund's return with a combined 29.5% of assets. Other firms hold less than 7.4% share. The fund has amassed $390.5 million in its asset base while sees good volume of 308,000 shares a day. It charges 44 bps in annual fees and has shed 10.7% so far this year.

Original Post