Bank ETFs Rally On Higher Interest Rates

The SPDR S&P 500 ETF Trust SPY hit a multi-month low on August 7, but rallied to a new all-time high on September 18. Reflecting the market's Monday fall the ETF has retreated a little, but is still up significantly from the August low.

Leading the way up have been the banking stocks.

The Select Sector Financial Slct Str SPDR Fd XLF is up 7.4 percent over the same time and is now trading at the best level since early 2008. XLF is the largest bank ETF, composed of 87 publicly traded companies.

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The portfolio is made up of 35 percent banks along with other subsectors in the finance world. As of September 22, the top three holdings included Wells Fargo & Co with an 8.7 percent holding, Berkshire Hathaway Inc. Class B at 8.7 percent as well and JPMorgan Chase & Co. at 7.9 percent.

The ETF pays a 1.56 percent dividend and charges an annual expense ratio of 0.16 percent.

While the SPY is trading in unchartered territory, XLF remains 37 percent below its all-time high set in 2007. The financial ETF may not reach the 2007 level anytime soon, but it does give XLF room to move to the upside. The reason for the underperformance since 2007 is fairly clear; the financial collapse that swept the global markets.

With that being a known factor and seven years in the past, the view towards the financial stocks has changed dramatically.

Regional Option

Another way to play the banks is through the smaller, less complex regional banks. The iShares Dow Jones U.S. Reg Banks Ind ETF IAT is made up of 57 U.S.-based regional banks, but it is less diverse than that sounds: The top three holdings make up just under 40 percent of the entire portfolio.

The top three are U.S. Bancorp coming in at 19.9 percent, PNC Financial Services Group Inc at 12 percent and BB&T Corporation at 7.1 percent. Since August 7 the ETF has outperformed both SPY and XLF with a gain of 8.2 percent.

The annual dividend yield is 1.69 percent and the expense ratio is slightly higher than XLF at 0.43 percent.

Higher interest rates are almost inevitable in the coming years, and as they increase it could help the bottom line for the financials that lend money. The margins for lending will increase for both the large and regional banks. Add in the fact that both ETFs trade well below their all-time highs, there is room to run to the upside for the bank stocks.