Bank ETFs Get Whipsawed by Investors as Yellen CommentsElizabeth Dexheimer and Christopher Condon
Exchange-traded funds that target financial firms were whipsawed as Federal Reserve Chair Janet Yellen’s remarks on interest rates left investors struggling to gauge how soon future increases will help U.S. bank profits.
Financial-industry ETFs took in $868 million from March 19 through last week, more than funds for any other sector, after Yellen signaled borrowing costs might rise in 2015’s first half, according to data compiled by Bloomberg. The surge reversed on March 31 with investors pulling $324 million after Yellen said the Fed will maintain its stimulus for “some time.” That could mean rates and related earnings stay low for longer.
Weak demand for bank ETFs had been the rule through most of the past five years as profit margins on loans shriveled. Investors rushed to buy the funds, helping drive up State Street Corp., Wells Fargo & Co. and Capital One Financial Corp. after Yellen’s remarks last month fanned speculation about higher rates. Her comments this week left investors looking for better interest spreads later in 2015 or 2016.
“A steepening of the yield curve combined with rising short-term interest rates will favorably impact bank profitability,” Gerard Cassidy, an analyst at RBC Capital Markets in Portland, Maine, said in a March 28 interview. He’s not telling clients to pull back from the industry. “We want investors to own bank stocks going into the first Fed funds rate increase, because as soon as that happens, everyone is going to start chasing them,” he said.
The $18.7 billion Financial Select Sector SPDR Fund, managed by Boston-based State Street, led the surge after Yellen’s comments two weeks ago, grabbing $584 million before investors pulled $309 million on March 31. The $2.7 billion SPDR S&P Regional Banking ETF also was among the top 10 asset-gatherers among industry ETFs until that day, when investors withdrew $32.6 million. Those two funds, along with the $2.7 billion SPDR S&P Bank ETF, are the largest focused on U.S. lenders.
The retreat from bank stocks continued yesterday as ETF investors withdrew an additional $2.86 million from all financial-focused funds, according to data compiled by Bloomberg.
Higher rates could relieve bankers whose profits have been squeezed by a revenue slump and rising costs. A yield curve plots interest rates over different lengths of time, so a steeper curve creates more of a spread or profit margin for banks between what they pay for short-term deposits and the longer-term yields they can earn on lending and investments.
The process of going from near-zero rates to a more typical level could backfire if funding costs rise before the yields on loans and investments, according to David Hilder, an analyst at Drexel Hamilton LLC in New York.
“There’s no way to say what the path to more normal rates is going to look like,” Hilder said. “The Fed may not start raising rates until the second half of 2015 or perhaps later.”
In her first press conference as head of the central bank, Yellen said March 19 that borrowing costs could start to rise six months after the Fed stops buying bonds. Yields on two-year Treasury notes climbed as much as 0.1 percentage point, the most since June 2011, after she spoke.
“Investors are starting to take note of changes in the market dynamics following Yellen’s testimony,” Anton Dorokhin, lead ETF specialist at Boston-based Windhaven Investment Management, said in an interview last week. “It goes back to the sensitivity to the broader macro theme of rising interest rates.”
From March 9, 2009, the nadir for the Standard & Poor’s 500 after the financial crisis, through the end of 2013, the same category of ETFs captured $12.2 billion. That was 10 percent of the money directed to industry-focused ETFs and 1.7 percent of all U.S. ETF deposits, the data compiled by Bloomberg show. Real-estate firms attracted 18 percent of the money sent to industry funds, while technology companies drew 16 percent.
ETFs are investment funds that typically track an index of stocks, bonds, commodities or other securities. Unlike mutual funds, their shares trade on an exchange like common stocks. As investors inject money, industry-specific ETFs buy equities, contributing to price moves.
Financial Select rose 3.3 percent last month, including reinvested dividends, and Regional Banking climbed 4 percent, while the S&P 500 increased 0.8 percent.
Financial Select tracks an index composed of banking and financial-services companies in the S&P 500 Index. Its two largest holdings are San Francisco-based Wells Fargo, the top U.S. mortgage lender, and New York-based JPMorgan Chase & Co., the nation’s biggest bank.
Regional banks have led U.S. financial-stock gains this year. Birmingham, Alabama-based Regions Financial Corp. and Pittsburgh-based PNC Financial Services Group Inc. posted the biggest advance in the 24-company KBW Bank Index, both rising more than 12 percent through yesterday.
“The stocks are trading off of macro themes as opposed to the underlying fundamentals of the companies themselves,” Todd Hagerman, an analyst at Sterne Agee & Leach Inc. in New York, said of financial shares. “Where investors are migrating is to those companies that offer the best leverage towards an improving economy.”
Even after a two-year rally in U.S. banks, valuations are below levels that preceded 2008’s credit crisis. The four largest -- JPMorgan, Bank of America Corp., Citigroup Inc. and Wells Fargo -- trade at an average of 1.44 times tangible book value compared with 2.73 times in 2007, according to data compiled by Bloomberg. Tangible book value measures a company’s net worth after stripping out assets such as goodwill and brand names that tend to have little or no value in a liquidation.
Comparable ratios at the two biggest regional lenders -- Minneapolis-based U.S. Bancorp and PNC -- also are more than a third lower than before the 2008 financial crisis. Firms listed in the S&P 500 Financials Index traded for an average of 14 times forward earnings yesterday, compared with the average of 16 times in the broader S&P 500.
“They have become so cheap relative to the market that it simply became a question of playing catch-up,” Michael Holland, who oversees more than $4 billion including bank stocks at Holland & Co. in New York, said in an interview.
Investors may get more information from lenders on expectations for interest rates when they post quarterly results later this month. JPMorgan and Wells Fargo report on April 11, followed by New York-based Citigroup on April 14 and Charlotte, North Carolina-based Bank of America on April 16.
“If they could get relief on the spread environment combined with growing loans, it’s going to be very powerful for bottom-line earnings,” said RBC Capital’s Cassidy.