Bank ETFs Get A Lift From Moody's Call

Financial services ETFs, already among this year's top-performing sector funds, got another lift Tuesday on the back of constructive comments from Moody's Investors Service.

Shares of the Financial Select Sector SPDR (NYSE:XLF) and the Vanguard Financials ETF (NYSE:VFH) are both up more than one percent after Moody's boosted its outlook on the U.S. banking system to stable from negative.

The Moody's upgrade of the U.S. banking system reflects "continued improvement in the operating environment and reduced downside risks to the banks from a faltering economy," said the ratings agency in a statement. The outlook had been negative since 2008.

Among other ETFs benefiting from the Moody's upgrade is the $1 billion iShares Dow Jones U.S. Financial Sector Index Fund (NYSE:IYF), which is up nearly one percent.

While Moody's is mostly bullish on the U.S. banking sector over the next 12 to 18 months, the ratings agency did call attention to the double-edged presented to banks by today's low interest rate environment.

"The low interest rate environment is the single most important issue that will drive U.S. banks' performance in the next 12-18 months. Low rates help to promote private-sector employment growth that more than offsets government job losses; low interest rates also have supported the recent improvements in the banks' asset quality metrics, with net charge-offs now approaching pre-crisis levels," said Moody's.

However, the ratings agency noted "low interest rates also harm U.S. banks' pre-provision earnings in both the near- and medium-term. Most immediately, low rates reduce a key source of profitability - banks' net interest margins. In addition, low rates encourage looser loan underwriting standards as banks seek out higher return, and consequently higher risk, assets. This will result in greater credit costs, reducing pre-provision earnings, in the future."

Year-to-date, IYF, VFH and XLF are up an average of 20.2 percent with XLF leading the way with a gain of 20.8 percent. With $13.56 billion in assets under management and an expense ratio of 0.18 percent, XLF is the largest and least expensive ETF tracking U.S. banks and financial services firm. VFH has an annual fee of 0.19 percent.

All three funds have similar holdings with familiar names such as J.P. Morgan Chase (NYSE:JPM), Wells Fargo (NYSE:WFC) and Warren Buffett's Berkshire Hathaway (NYSE: BRK-B) appearing among the top-10 lineups of each ETF.

Other top-10 holdings in the ETFs include Dow components American Express (NYSE:AXP) and Bank of America (NYSE:BAC) along with Goldman Sachs (NYSE:GS). VFH has the most holdings with 515.

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