Bank ETFs Surge: Will The Momentum Last?

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Includes: IAI, IAT, KBE, KBWB, KBWR, KRE, QABA
by: Zacks Funds

Finally, the battered banking stocks found reasons to turn around. As soon as the April Fed minutes hinted at a June rate hike possibility, banking, along with many other financial stocks, rallied on May 18. The going was tough for bank stocks and ETFs for quite some time, mainly due to the twin attacks of a delay in any further Fed rate hike after a liftoff in December and the energy sector slump. But things are now falling in space for this woebegone sector.

Hawkish Tone in Fed Minutes

Citing plenty of positive drivers in the market, including a healing labor market, a bullish inflation outlook, strong retail, consumer sentiment and housing data, the Fed minutes brought back the sooner-than-expected rate hike talks on the table.

The yield on the 10-year U.S. Treasury note jumped 11 bps to 1.87% on May 18, while the yield on the 2-year U.S. Treasury note rose 8 bps to 0.90%. This steepening of the yield curve was a tailwind for banking stocks, as these improve banks' net interest margins. This is because the interest rates on deposits are usually tied to short-term rates, while loans are often tied to long-term rates.

Revival in Oil Prices

U.S. banks have significant exposure to the long-beleaguered energy sector, where chances of credit default are higher. In February, the S&P cut its outlook on several regional banks with substantial energy sector exposure, citing a likely increase in non-performing assets.

Among the biggies, Wells Fargo (NYSE:WFC) reported around $42 billion oil and gas credit in February. The situation was the same for JPMorgan (NYSE:JPM), whose energy loan accounts for 57% of the investment-grade paper. JPMorgan's $44 billion energy sector exposure was a cause for concern given the below-$30-oil-per-barrel mark a few months back.

However, those days of crisis seem to have passed, with oil prices showing an impressive rally lately and hovering around a seven-month high on falling supplies and the possibility of rising demand. Political imbalance in countries like Nigeria and Venezuela and expected moderation in the shale boom should put a brake in the supply glut. This increased hopes for a revival in the energy sector, which, in turn, is likely to benefit the banking sector too.

JPMorgan Ups Dividend

This leading financial firm announced a dividend hike on May 17, 2016, after the market closed. The company declared a quarterly cash dividend of $0.48 per share, representing a more than 9% rise over the prior payout. Per analysts, the strength in its consumer businesses helped the bank to opt for this. JPM shares jumped about 3.9% in the key trading session of May 18, benefitting the ETFs that invest heavily in the company.

Notably, JPMorgan's first-quarter 2016 earnings of $1.35 per share beat the Zacks Consensus Estimate of $1.26. Net revenue of $24.1 billion was also ahead of the Zacks Consensus Estimate of $23.9 billion. Needless to mention, this announcement uplifted the big banks' financial image.

All these showered ample gains in banking stocks on May 18. Below, we highlight a few (see all Financial ETFs here):

  • SPDR S&P Regional Banking ETF (NYSEARCA:KRE) - Up 4.24%
  • SPDR S&P Bank ETF (NYSEARCA:KBE) - Up 4.15%
  • PowerShares KBW Regional Banking Portfolio ETF (NYSEARCA:KBWR) - Up 4.14%
  • First Trust Nasdaq ABA Community Bank ETF (NASDAQ:QABA) - Up 3.87%
  • PowerShares KBW Bank Portfolio ETF (NYSEARCA:KBWB) - Up 3.76%
  • iShares U.S. Regional Banks ETF (NYSEARCA:IAT) - Up 3.73%

Apart from banking sector ETFs, other financial ETFs also shined on May 18. Among the lot, the iShares U.S. Broker-Dealers ETF (NYSEARCA:IAI), up 3.11%,deserves a special mention. Notably, this ETF is also a beneficiary of the rising rate environment.

Going Forward

Since all the drivers are likely to remain in place for some time, the road ahead for banking ETFs should not be edgy. Even if the Fed does not act in June, it should act by September. Moreover, after two years of struggle, tension in the oil patch is likely to take a breather, as supply-demand dynamics look favorable for the near term. However, if bond yields decline on risk-off trade sentiments emanated from global growth issues, financial ETFs might come under pressure.

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