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The Editor-in-Chief of well-respected publisher ETF Stream, Tom Eckett, published a rare editorial Friday, March 24 saying the big selloff in banks fearing a contagion in banks was close to over. He said at these levels Bank ETFs were at rarely seen low levels compared with earnings expectations that should not be thrown off too much by the so-called crisis caused by half a dozen bad actors. He especially prefers ETFs to bank stocks in this situation because there is safety in numbers. So even if one more bad actor is found, the ETF won’t be hurt that much.

This week’s article consults the Value Engine’s predictive model on Bank ETFs and their top holdings. For a change, I’ll give the answer to the title question ahead of the analysis. The predictive and valuation models both agree with Tom. The momentum against banks is showing signs of settling and no longer resembling a falling knife. The stocks of strong banks with high earnings expectations are now selling at what our valuation model considers bargain prices. So yes, if you are an active or semi-active investor you may wish to consider bank ETFs and bank stocks now, 

The three ETFs used in this analysis are:

XLF – Financials Select Sector SPDR Fund.XLF offers efficient exposure to the heavyweights in the US financials segment. Its cap-weighted, S&P 500-only portfolio means that it’s concentrated in large banks and avoids small-caps.

KRE- SPDR S&P Regional Banking ETF. KRE covers the regional banks segment of the S&P Total Market Index, an index that tracks the broad US equity market. Companies that meet certain market-cap and liquidity requirements will be included in the fund’s final holdings. Selected securities are then equally-weighted, subject to liquidity constraints. Overall, KRE’s equal-weighting scheme reduces single stock risk in the smaller names and helps to draw further distinctions from peers with big positions in large-cap names.

KBWR - Invesco KBW Regional Banking ETF. KBWR doesn't attempt to provide broad exposure to the US banking segment. Instead, the fund employs an index committee selection process, along with modified market-cap weighting to construct a portfolio of regional banking and thrift firms. This process makes an already small-cap-oriented portfolio tilt even smaller. In fact, KBWR's portfolio has one of the smallest average market caps in the segment. The fund's scope does not stray from its narrow mandate. It provides the exact exposure it promises, with no industry tilts.

This trio provides very different choices for potential investors that look under their hoods.XLF is simply a cap-weighted slice of banks, credit issuers, and insurance companies that are in the S&P 500 Index. It includes Berkshire Hathaway, JP Morgan Chase, Goldman Sachs, Mastercard Int’l., Citi, etc.  KRE focuses on regional banks in an index that includes midcap and small cap stocks and is equally weighted. New York Community and Citizens are its largest holdings.KBWR uses a committee to make active selection of stocks in its index to hold many small regional banks. Its average market cap tends to be lower than even that of KRE.  

These three financial and Bank ETFs are compared with IVV, iShares S&P 500 Index ETF, serving as a proxy for the broad US stock market. All data as of March 26. 2023.

Analysis 

1. The three financial sector ETFs, XLF, KRE and KBWR are all rated 5 (Strong Buy). 

2. The most conservative of the three, XLF – SPDR S&P 500 ETF - is very undervalued by traditional metrics with a 1.6 Price/Book Ratio; a 15.5 P/E Ratio and a Dividend Yield of 2.2%.Because it also contains insurance and credit-issuing companies, it held up better than the ETFs that were comprised 100% of banks during the contagion. Among its top 10 holdings, there is one rated 4 (Buy) by the ValuEngine Model, Wells Fargo (WFC).

3. Both regional bank ETFs, KRE and KBWR are also rated 5 (Strong Buy). They have higher forecast 1-year returns than KRE and KBWR and have higher upside rebound potential as confidence slowly gets restored to regional banks.It should be noted that the selection mechanism used by KRE includes balance sheet strength among its selection criteria. More than 90% of the stocks contained in both ETFs are considered undervalued by our model.

4. KRE has more attractive fundamentals than KBWR. It also contains five stocks we now rate as buy among its top ten: Zions Bancorp (ZION), 5 (Strong Buy); M&T Bank Corp (MTB) 4 (Buy); First Horizon Corp (FHN) 4 (Buy); East West BC (EWBC) 4 (Buy); Webster Financial (MTB) 4 (Buy). A P/B ratio of 1.3, P/E of just 10.9 and a yield of 3.4% with strong diversification makes KRE well worth investigating as a potentially very timely opportunity.

Summary

Financial and banking stocks have been beaten down badly by the recent confidence crisis brought about by the failures of Silicon Valley Bank, Credit Suisse, and a handful of others globally. The good news is that all recent news seems to point to an isolated crisis hitting a few banks that strayed from conservative banking practices. The consensus now is that the overall US banking system is not in as much danger as many initially thought.  Earnings projections, for the most part, are holding strong. The VE predictive model has identified this to potentially be a strong buying opportunity for financial and regional bank ETFs and several of the bank stocks they hold.

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