Modest Love For Regional Bank ETF As Rate Hike Looms

In the week since the Federal Open Market Committee (FOMC) meeting minutes revealed the Federal Reserve could raise interest rates for the first time this year in June, financial services stocks and exchange traded funds are reacting as expected.

For example, the Financial Select Sector SPDR XLF, one of the laggards among sector ETFs this year, is higher by 2.6 percent over the past week. Over that stretch, investors have pumped $436.3 million into XLF, the largest ETF tracking the financial services sector.

Investors' enthusiasm for regional bank ETFs, a group of funds far more positively correlated to rising interest rates than are diversified financial services ETFs, has not been as robust. Still lighter by $92.5 million month-to-date, the SPDR S&P Regional Bank ETF KRE added just $26.7 million in new assets for the week ended May 25. KRE, the largest regional bank ETF by assets, is higher by 3.7 percent over that period.

Earlier this year, short sellers targeted regional banks with exposure to the energy sector, including some KRE holdings that are based in oil and gas-rich Oklahoma and Texas. However, rebounding energy commodities have forced a spate of short-covering among even highly distressed exploration and production firms, bringing some relief to regional bank names. 

Remember, it was not until last week that fixed income markets started recalibrating expectations for a June rate hike, yet KRE is higher by more than 16.1 percent over the past 90 days.

Regional bank funds like KRE are seen as prime beneficiaries of higher interest rates. Simply put, net interest margins at regional banks have been suppressed by the Fed's zero interest rate policy and reversing that policy is seen as an important catalyst in boosting profits for the banks in ETFs such as KRE.

Higher interest rates are seen as boons for regional banks' net interest margins, a key measure of profitability for these banks. KRE's positive correlation to rising Treasury yields is nearly double that of XLF's and more than quadruple of that S&P 500. Translation: KRE is more levered to rising rates than traditional financial services ETFs so those that get long this ETF in the coming weeks need some help from the Fed.

Todd Shriber owns shares of XLF.