Bank ETFs Dodge Dip from Downgrades

Banks boosted the financial sector into the green Friday, bouncing back on the heels of several global bank downgrades late Thursday.  Moody’s downgraded the ratings of 15 of the world’s biggest banks and securities firms, citing risk of large losses from capital markets activities.

The largest cuts came to European banks;  Spanish bank La Caixa and France’s BNP Parbias both received a 5-notch downgrade.

Morgan Stanley (NYSE:MS), the U.S. bank speculated to suffer the most from the round of cuts, was downgraded two notches, bumped to Baa1 from A and short of the three bumps that were originally feared.   But the downgrades didn’t take the financial sector by surprise; Moody’s first flagged the review of 17 of the world’s largest banks on February 15.

“This has been a very well telegraphed move, one the Street was prepared for,” said David Lutz, Stifel Nicolaus Managing Director.

In the broad market, the Financial Select Sector SPDR (NYSE:XLF), the most heavily traded financial-sector exchange-traded fund, closed in the green, up 0.92%. XLF holds four of the five downgraded U.S. banks in its top 10 holdings.

The iShares Dow Jones U.S. Financial Sector (NYSE:IYF), which holds three of the five downgraded U.S. banks in its top five holdings, climbed 0.95%. JPMorgan (NYSE:JPM), Bank of America (NYSE:BAC) and Citigroup (NYSE:C) account for more than 13% of the fund’s portfolio weight.

Wells Fargo (NYSE:WFC), the only major U.S. bank to emerge from Moody’s downgrades unscathed, is the top holding of both funds. Wells Fargo accounts for nearly 10% of XLF and more than 7% of IYF.

Of the five U.S. banks that were hit with downgrades, Goldman Sachs (NYSE:GS) was the only firm to close the trading day in the red.  Goldman Sachs was cut two notches to A3.

So is there still investment opportunity in financials, or do the downgrades prove the sector is too risky?

“The opportunity for the financials is on the short side, not the long side,” said John Stephenson, First Asset Investment Management Senior Vice President and Portfolio Manager. “It's hard to see the banks performing with global growth shrinking, the consumer deleveraging and capital markets activity shrinking.”