After Strong Runs, Regional Bank ETFs Still Have Upside

Financial services ETFs have been among the top-performing sector funds this year and following one firm's constructive comments on U.S. banks, major bank ETFs may still have more upside in store for investors.

It is easy to focus on the largest bank ETFs, such as the Financial Services Select Sector SPDR XLF, but those funds with significant allocations to regional banks also merit consideration. An improving U.S. housing market is one reason why.

"In past years, house prices rose most strongly in April, so a March increase so early in the spring selling market could bode well for April, and possibly for the rest of the year and beyond, in our view," said S&P Capital IQ in a new research note. "We believe several factors are driving the price increases, including improving consumer confidence, low interest rates, and a shortage of homes, as well as investor purchases of homes to rent out. Looking further out, we think home prices may be helped by population growth, and could even get a boost from potential federal immigration reform legislation."

In the note, S&P Capital IQ revealed four-star ratings on Regions Financial RF and Synovus SNV, two regional banks that saw their shares hammered during the financial crisis. This year has been a different story as Regions has surged 26.3 percent while Synovus is up seven percent in the past 90 days.

"We see Regions Financial taking strong steps toward internally generating capital, further improving credit quality, and turning loan and revenue growth positive, after many years of shrinkage," said S&P Capital IQ. "First-quarter 2013 net
chargeoffs (writeoffs of uncollectible loans, net of recoveries of collateral) fell 45% from a year earlier. Loan loss provisions declined to only $10 million, from $170 million a year earlier, and nonperforming loans at quarter end fell to a better-than-peers 2.15% of loans, from 2.80%. We expect modest loan shrinkage of 2.0% in the next two quarters, with slow loan growth resuming in late 2013. About 33% of RF's loan portfolio, at March 31, is residential mortgages, higher than many peers."

Synovus is seen as a turnaround story after bolstering its balance sheet and the bank could be in a position to grow its loan base this year.

In terms of regional bank ETFs, investors have some credible options, including the iShares Dow Jones U.S. Regional Banks Index Fund IAT. IAT, which has almost $384 million in assets under management, is up 13.5 percent year-to-date. The ETF features Regions among its top-10 holdings, but investors should note this ETF is heavily allocated to super regionals US Bancorp USB and PNC Financial PNC. That pair combines for 31 percent of the ETF's weight.

Another ETF to consider is the PowerShares KBW Bank Portfolio KBWB, which has $135 million in AUM. KBWB has gained over 17 percent and the reason for its out-performance of IAT may be attributable to its allocations to some of the largest U.S. banks, which cannot be considered regional plays.

For example, Bank of America BAC, Citigroup C, J.P. Morgan Chase JPM and Wells Fargo WFC combine for about 37 percent of the ETF's weight. However, 16 of KBWB's 24 holdings can be considered regional or super regional names.

S&P Capital IQ rates both ETFs Overweight. KBWB has an expense ratio of 0.35 percent while IAT charges 0.45 percent per year.

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