Despite facing new and fresh stress tests, large-cap financial institutions appear to be positioned for earnings-per-share growth in 2011, making the Financial Select Sector SPDR (XLF) and the iShares Dow Jones US Regional Banks Index Fund (IAT) attractive.

According to an article in Barron’s magazine, Credit Suisse expects large-cap financial institutions like Bank of America (BAC), JP Morgan Chase (JPM), Wells Fargo (WFC), PNC Financial Services (PNC), US Bancorp (USB) and Citigroup (C), to witness earnings-per-share growth of 25 percent.  The true driver behind this profitability is expected to be improving credit costs and more active capital management. 

Furthermore, the article states that the large-cap financial institutions do face headwinds due to the newly implemented Basel proposals, which included stress tests that are expected to determine which financial institutions have healthy enough balance sheets to increase dividends and buy back shares, however, with healthy organic capital generation should be able to absorb the revised standards with no drastic impacts. 

In addition to the aforementioned, the implementation of QE2 benefits large financial institutions in that it is keeping short-term interest rates at near-record lows and has pushed long-term interest rates higher, generating somewhat of an arbitrage opportunity.  Large financial institutions are able virtually for free and lend long-term at higher interest rates, and this trend is expected to continue to prevail in the near term future enabling large financial institutions to reap the benefits. 

As mentioned earlier, some ETFs to capitalize on this possible opportunity include:

  • Financial Select Sector SPDR (XLF), which boast 81 different holdings and boasts JP Morgan Chase, Wells Fargo, Bank of America and Citigroup as its top holdings.
  • iShares Dow Jones US Regional Banks Index Fund (IAT), which has 66 different holdings and boasts US Bancorp and PNC Financial Services as its top two holdings, accounting for nearly 29.7% of the ETF’s assets.

Disclosure: No Positions

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