Another Reason To Consider Bank ETFs

Once lagging financial services stocks and exchange traded funds have recently sprung to life amid speculation the Federal Reserve is nearing its first interest rate increase of 2016, perhaps as soon as this month. However, there are reasons investors should consider ratcheting up exposure to the second-largest sector weight in the S&P 500.

As has been previously highlighted in this space, members of ETFs such as the Financial Select Sector SPDR XLF were among the worst dividend offenders during the global financial crisis, but since then, many marquee XLF components have been diligently working to restore their dividend reputations as the Fed allows them to do so.

The financial crisis undid decades' worth of dividend ebullience from big banks in short order, leaving some income investors scorned and doubting the sector's future dividend growth prospects. Some dividend ETFs still have relatively low weights to the financial services sector because those ETFs rely on dividend increase streaks as part of their weighting methodology, indicating sector ETFs could be the preferred avenues for playing financial services dividend growth.

“US banks are likely to seek to increase their capital distribution plans in the Federal Reserve's (Fed) stress test process this year as they have become more comfortable with the process and creative with their capital requests, Fitch Ratings says. Banks are increasingly utilizing the re-submission option and requesting additional capital returns mid-cycle,” said Fitch Ratings in a recent note. 

Coming off low bases seen during the financial crisis, some XLF components have exhibited staggering dividend growth. Just over five years ago, J.P. Morgan Chase & Co. JPM had a quarterly dividend of 5 cents a share. Today, the Dow component pays 44 cents a share per quarter. Wells Fargo & Co. WFC was paying a dividend of 5 cents a share per quarter as recently as early 2011, but that number is up to 38 cents a share on a quarterly basis.

J.P. Morgan Chase and Wells Fargo combine for about 16 percent of XLF's weight. XLF, the largest financial services ETF, yields nearly 2.1 percent.

“Despite a desire to increase total payouts, Fitch notes that some bank holding companies' cushions over various capital ratios were very thin during last year's stress test, which may dampen higher payout requests. For the trust and processing banks, the Tier 1 leverage ratio tends to be the constraining ratio, while for the large trading and universal banks, Tier 1 risk-based and total capital ratios tend to be the constraining ratios,” according to the Ratings Agency.

Further dividend increases from the likes of Bank of America Corp. BAC and Citigroup Inc. C, two stocks that combine for nearly 10 percent of XLF's lineup, would potentially bolster confidence in banks' dividend stream. Those banks each pay quarterly dividends of just 5 cents a share.

Todd Shriber owns shares of XLF.