Price is what you pay. Value is what you get – Warren Buffett

The current low interest rate scenario is something investors should be aware of. Bank profits are directly correlated to the benchmark interest rate. Given the current situation with 0% interest rates, banks have hit net income and net interest margins (NIMs). Investors should be cautious because interest rates are expected to remain extremely low in the medium term.

The SPDR S&P Regional Banking ETF (NYSEARCA:

Total Return Analysis

In terms of total returns, KRE sits in the middle of its peer set over five years*. Going forward, investors should not expect any significant improvements in earnings growth as long as the interest environment remains low. The Fed expects to start increasing the rates in 2023, or until the economy has shown a full recovery, whichever is earlier.

*Note: FTXO was listed in September 2016

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Constituent Holdings

Source: Seeking Alpha

The fund’s entire exposure is the financials/banking sector. The top 10 holdings make up about 34.6% of the fund’s exposure. Let us look at the earnings estimates for the coming years to get an idea of the kind of profitability we can expect.

YoY

2020E Rev Growth

2020E EPS Growth

First Republic Bank

14.25%

8.77%

Regions Financial Corp.

4.23%

(47.48%)

SVB Financial Group

9.69%

(12.96%)

Fifth Third Bancorp.

(9.03%)

(32.84%)

Truist Financial Corp.

74.27%

(19.10%)

Huntington Bancshares

3.50%

(45.64%)

KeyCorp

2.74%

(37.11%)

M&T Bank Corp.

(5.61%)

(33.19%)

PNC Financial Services Group

(5.70%)

(51.41%)

Citizens Financial Group

5.81%

(42.35%)

Average

9.42%

(31.33%)

Source: Seeking Alpha

In 2020, due to the slowdown in economic activity, banks had to start putting more funds into provision accounts to cover the potential shortage in interest payments from depositors. These rise in provisions are expected to have a severe impact on earnings for 2020. As is clear from the table above, all banks in KRE’s top 10 holdings, barring First Republic Bank (NYSE:FRC), are expected to witness a drop of at least 12% in EPS. Some banks such as Fifth Third Bancorp (NASDAQ:FITB), Regions Financial Corp. (NYSE:RF), and PNC Financial (NYSE:PNC) will see a drop of over 45%.

Even as the average top 10 revenue growth is expected to be positive, earnings average is expected to drop over 30%.

Reasonably Valued in the Current Scenario

Compared with its peers, KRE is modestly valued. The economic slowdown has dramatically impacted the NAVs of these funds, which has led to valuations at the lower end of the long-term average.

P/E

P/B

P/S

SPDR S&P Regional Banking Index (KRE)

10.80

0.79

2.26

iShares U.S. Regional Banks ETF (NYSEARCA:IAT)

11.72

0.87

2.45

First Trust Nasdaq Bank ETF (NASDAQ:FTXO)

11.14

0.86

2.32

SPDR S&P Bank ETF (NYSEARCA:KBE)

9.75

0.77

1.95

First Trust Community Bank ETF (NASDAQ:QABA)

11.50

0.86

2.74

Source: Morningstar

Comparison With Peers

From the table below, we can see that KRE is the largest ETF tracking regional banks when measured by AUM. Also, it had the lowest expense ratio in the segment.

Another strong point about KRE is that its fund contribution is not concentrated in its top 10 holdings, unlike IAT and FTXO, which have >60% exposure to their top ten holdings.

All banking stocks have been taking a beating ever since monetary policy structures changed in 2018, with the Fed continuously slashing interest rates. However, over the last three years, KRE is not the worst performer in the space. It witnessed a drop of 10.30% over the period, far less than the negative returns delivered by FTXO and QABA.

With a TTM dividend yield of 2.81%, KRE is relatively on the higher end of the spectrum, and it has increased its dividend at a CAGR of 18.36% over the past three years.

KRE

IAT

FTXO

KBE

QABA

Issuer

State Street

iShares

First Trust

State Street

First Trust

Inception

06/19/2006

05/01/2006

09/20/2016

11/08/2005

06/29/2009

Expense Ratio

0.35%

0.42%

0.60%

0.35%

0.60%

AUM

$1.59bn

$333.41mn

$83.11mn

$1.57bn

$65.55mn

Holdings

128

58

29

89

163

Assets in Top 10

34.62%

63.79%

61.54%

21.07%

23.44%

3 Year Price Performance

(10.30%)

(5.45%)

(16.81%)

(9.83%)

(15.33%)

TTM Dividend Yield

2.81%

3.03%

3.07%

2.62%

2.56%

3 Yr. Dividend CAGR

18.36%

22.51%

22.16%

19.39%

Source: Seeking Alpha

What Are the Risks to Be Considered?

Non-diversified fund: Given that the fund holds a portfolio of regional banks, it is not diversified and has sector-specific risks associated with it. The longer the current interest rate regime prevails, the longer we will have to wait to see meaningful earnings growth.

Banking sector headwinds: The performance of bank stocks may be affected by extensive governmental regulation, which may limit both the amounts and types of loans and other financial commitments they can make, and the interest rates and fees they can charge, and the amount of capital they must maintain. With interest rates hovering around 0% currently, the bank’s bottom line has taken a beating. Many banks were forced to increase reserves due to credit losses over the past quarter.

Non-diversified revenue streams: Most regional banks do not have diversified revenue streams, which its larger competitors enjoy. As such, their profitability is pinned to single revenue lines, which poses a significant risk.

Conclusion

Overall, the market outlook for the short-term looks doubtful for banks, primarily regional banks. Reducing net interest and net income margins will continue to be driven by the current interest rate regime. However, investors with a longer-term horizon can consider these regional bank ETFs as a “value pick” at current price levels. KRE is a good option on a couple of fronts. Hopefully, as the global economy starts to get back on track, regional bank ETFs will see a rebound.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This writing is for informational purposes only and Lead-Lag Publishing, LLC undertakes no obligation to update this article even if the opinions expressed change. It does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction. It also does not offer to provide advisory or other services in any jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Lead-Lag Publishing, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.