After making a solid comeback and logging the best month since November 2016, the U.S. regional banking sector has been caught in feeble trading lately, triggered by the series of bank downgrades. Notably, the KBW Nasdaq Regional Banking index has plunged 13% so far this month.

The ETFs in the space also declined. SPDR S&P Regional Banking ETF KRE, iShares U.S. Regional Banks ETF IAT and Invesco KBW Regional Banking ETF KBWR are down 5.3%, 7.5% and 5.4%, respectively over the past month.

What Happened?

Earlier this week, rating agency S&P Global cut its credit ratings on some regional lenders with high commercial real estate exposure, citing a “tough” lending environment currently. It lowered its ratings of five banks and put two others on notice for potential downgrades.

This decision, as reported by Reuters, is attributed to rising funding costs and challenges in the commercial real estate sector, which are anticipated to challenge the creditworthiness of these lenders. The relentless series of rate hikes by the U.S. Federal Reserve has compelled banks to offer higher interest rates. This is because higher rates have raised costs at banks, which now must pay more interest on deposits to keep customers from seeking higher-yielding alternatives.

S&P Global’s move mirrors the actions of Moody’s, which had previously downgraded the credit ratings of 10 small to mid-sized U.S. banks by a notch. The rating agency said rising funding costs, a possible decline in deposit levels and weaker profitability pose risks to the banking sector. It also warned that it might cut ratings of some of the biggest U.S. lenders and placed six banks under review for a potential downgrade.

Further, another chief rating agency, Fitch also warned that several prominent U.S. banks, such as JPMorgan Chase, might face downgrades if the banking sector’s “operating environment” continues to worsen. In June, the credit agency downgraded the score of the U.S. banking sector’s “operating environment” to “AA-“ from “AA,” raising concerns over the health of the sector.

We have profiled the abovementioned ETFs below:

SPDR S&P Regional Banking ETF (KRE)

SPDR S&P Regional Banking ETF provides exposure to the regional banks segment by tracking the S&P Regional Banks Select Industry Index. It holds 139 stocks in its basket, with each accounting for no more than 2.4% of the assets.

SPDR S&P Regional Banking ETF has AUM of $2.7 billion and charges 35 bps in annual fees. It trades in an average daily volume of 16.7 million shares and has a Zacks Rank #4 (Sell).

iShares U.S. Regional Banks ETF (IAT)

iShares U.S. Regional Banks ETF offers exposure to 35 small and mid-cap regional bank stocks by tracking the Dow Jones U.S. Select Regional Banks Index. It is largely concentrated on the top three firms with a double-digit allocation each.

iShares U.S. Regional Banks ETF has amassed $671.9 million in its asset base while seeing a good volume of 512,000 shares a day. The product charges 40 bps in annual fees and has a Zacks Rank #4.

Invesco KBW Regional Banking ETF (KBWR)

Invesco KBW Regional Banking ETF offers exposure to publicly traded U.S. regional banking and thrift companies by tracking the KBW Nasdaq Regional Banking Index. It holds 51 stocks in its basket, with none accounting for more than 4.1% of assets.

Invesco KBW Regional Banking ETF is a relatively less-popular and less-liquid option in the space, with AUM of $57.5 million and an average daily volume of 11,000 shares. It charges 35 bps in fees per year from investors and has a Zacks Rank #2 (Buy).

Any Bright Spots?

Despite the series of downgrades, banks are in a better position, possessing healthier balance sheets than before and higher-quality loans with more money set aside to cover surprise losses. Interest income rose and deposits have also been stabilized.

Additionally, the resilient economy backed by strong hiring, rising consumer confidence and increasing wages will continue to support the banking industry. With the ongoing economic recovery, technological advancements and favorable monetary policies, regional banks are poised for further growth and could continue to be an attractive option for investors seeking promising opportunities in the financial markets.
SPDR S&P Regional Banking ETF (KRE): ETF Research Reports

iShares U.S. Regional Banks ETF (IAT): ETF Research Reports

Invesco KBW Regional Banking ETF (KBWR): ETF Research Reports

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