When the U.S. financial sector experienced an unprecedented meltdown and set off a global recession, many investor wondered just how far financial stocks would slide. After struggling to find a bottom for nearly two years, many financials ETFs have found their footing since hitting market lows in March, posting solid gains for the year.
But there are a few glaring exceptions.
Regional banks ETFs, funds that invest in equities of small and mid-sized financial institutions, have lagged behind many other financials ETFs in 2009, as institutions continue to fail at an alarming rate. Last week, regulators seized three small banks, bringing the total of U.S. banks that have failed in 2009 to 98. Among the 24 ETFs included in the Financials ETFdb Category, only five are in the red for the year, including two regional bank ETFs.
The number of bank closures in 2009 is already the highest since the savings-and-loan crisis in the early 1990s. And regulators think we’re still far from a bottom. Hundreds of additional banks are expected to fail before the current financial downturn is over.
But regional bank funds have shown signs of life lately, with many investors expecting earnings to beat consensus estimates for the third quarter. But the Federal Reserve recently expressed concern over the reserves accrued for losses on commercial real estate loans, setting the stage for another wave of huge writedowns as commercial real estate values slide and huge amounts of debt need to be refinanced. “More pain likely lies ahead for this sector and for those banks with heavy commercial real estate exposures,” said New York Federal Reserve President Bill Dudley in a speech recently.
Regional Bank ETFs
Investors looking to gain exposure to regional banks have two primary options: the iShares Dow Jones U.S. Regional Bank Index Fund (IAT) and SPDR KBW Regional Banking ETF (KRE). While these ETFs generally track similar sub-sectors of the financial industry, there are a number of significant differences between the funds that have led to diverging returns in 2009.
The most significant difference between IAT and KRE is the weighting methodologies employed by the underlying indexes. IAT tracks the Dow Jones U.S. Select Regional Banks Index, a market capitalization-weighted benchmark. KRE tracks the KBW Regional Banking Index, an equal-weighted benchmark. As such, a handful of companies make up a significant portion of IAT’s holdings, while KRE is more diversified across more than 50 different regional banks and thrifts. IAT’s largest holding, US Bancorp, makes up almost 17% of its holdings, while KRE’s largest individual holding is less than 3% of assets.
KRE also has a much lower price/book ratio than IAT. Price-to-book is an important metric in valuing banks, particularly in an environment where many asset bases have been eroded by writedowns of mortgages and commercial property loans.
|Index||Dow Jones U.S. Select Regional Banks Index||KBW Regional Banking Index|
|Largest Holding||US Bancorp (16.6%)||Firstmerit Corp (2.6%)|
|Top 10 Holdings||59.6%||21.5%|
Disclosure: No positions at time of writing.