Maybe Some M&A Activity For These ETFs

Down an average of 8 percent year-to-date, the SPDR KBW Regional Banking (ETF) (NYSE:KRE) and the iShares Dow Jones US Reg Banks Ind.(ETF) (NYSE:IAT) are prime examples of financial services exchange traded funds that have been confounded by declining Treasury yields.

Losses for more diversified ETFs tracking the sector are significantly less severe. For example, the Financial Select Sector SPDR Fund (NYSE:XLF) is down 6.5 percent year-to-date. It is not just declining Treasury yields that are hampering interest rate-sensitive regional bank stocks and ETFs. Oil prices are playing a part in these declines, too.

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Short sellers have gone after regional banks with exposure to the energy sector, including some KRE holdings that are based in oil and gas-rich Oklahoma and Texas. However, the current trying environment for regional bank stocks could stoke a fresh round of industry consolidation.

We expect bank M&A to be primarily motivated by cost savings but depressed stock prices may prevent some deals going ahead. Although some banks might prioritise share repurchase schemes over M&A given weak prices, we believe there is heightened appetite for consolidation. This is especially the case among large regional banks, mid-tier players and smaller lenders, said Fitch Ratings in a new note.

A Closer Look At IAT

Home to large, super-regional names such as U.S. Bancorp (NYSE:USB) and BB&T Corporation (NYSE:BBT), some of IAT's 54 holdings could be buyers in a new wave of regional bank consolidation. BB&T and PNC Financial Services Group Inc (NYSE:PNC), among other IAT holdings, have acquisitive histories.

PNC, BBT and other large-cap regionals are found among KRE's 93 holdings, but the ETF's holdings have a weighted average market value of just $9.2 billion. That could be a sign the ETF's exposure to mid- and small-cap regional banks could serve it well if industry consolidation comes to pass.

The impetus for mergers and acquisitions activity in the regional bank group could come from the fact that even if the Federal Reserve boosts rates several times this year, the benefit to net interest margins may not be enough to lift regionals' bottom lines.

Statements made during bank earnings' calls in mid-January indicated that most banks were expecting the US Fed to increase interest rates in summer 2016 and again towards the end of the year. Since then, volatile markets have raised uncertainty about further rate moves in 2016. Even so, we do not think interest rate hikes will provide much uplift to overall bank earnings in 2016 as the operating environment remains challenging. M&A could lead to cost savings, which could support earnings, added Fitch.

Disclosure: Todd Shriber owns shares of XLF.

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