XLF Financial Select Sector

Big U.S. banks are undergoing the sixth round of the Dodd-Frank Act supervisory stress test by the Fed, results of which are expected next week. Under this test, the 30 top-tier banks have to illustrate their capital strength to endure a major economic downturn.
 
After clearing the stress test, the banks would be able to offer healthy dividend increases to their shareholders. As such, dividend hikes from banking giants are likely to roll in the coming weeks. In particular, three big players - Citigroup (C), Bank of America (BAC) and Morgan Stanley (MS) are looking for huge increases in their dividends (read: 3 Financial ETFs to Watch on Volcker Rule Implementation).
 
According to Markit, Bank of America and Citigroup plan to raise their dividends by 400% each to 5 cents per share. This would translate into a 12% payout ratio and 1.2% yield for the former, and a 3% payout ratio and 0.4% yield for the latter. Morgan Stanley would double its dividend to 10 cents per share, resulting in a 14% payout ratio and 1.4% yield.
 
Other major banks such as Bank of New York Mellon (BK), JPMorgan (JPM), PNC Financial Services Group (PNC), State Street (STT), Wells Fargo (WFC) and U.S. Bancorp (USB) would see modest dividend growth in the range of 7%–20% because their payout ratios are already close to the Fed’s benchmark of 30%. 
 
Overall, Markit projects banking dividend growth of 25% for the second quarter compared to the first, should the banks successfully pass the stress test. If the predictions from Markit come true, then it could provide a strong boost to the dividend yields for a number of financial ETFs tracking these banking stocks (see: all the Financial ETFs here). 
 
Below, we have highlighted three ETFs that will are likely to be the major beneficiaries from the dividend increase, any of which could make for a solid play to tap the dividend-paying stocks of the financial sector:
 
Financial Select Sector SPDR Fund (XLF)
 
The most popular financial ETF on the market, XLF, follows the S&P Financial Select Sector Index. This fund manages about $16.7 billion in assets and trades in heavy volume of roughly 40 million shares a day. The ETF charges 16 bps in fees per year from investors. In total, the fund holds about 83 securities in its basket.
 
Out of these, seven banks that are poised for dividend hikes belong to the top 10 holdings line-up and collectively make more than one-third of the portfolio. In terms of industry exposure, the product is tilted toward diversified financial services at nearly 32% while insurance, commercial banks, capital markets and REITs account for double-digit allocation (read: Unpopular Sector ETFs to Start 2014).
 
XLF currently yields 1.49% in annual dividends and has lost 1% so far this year. The ETF has a Zacks ETF Rank of 1 or ‘Strong Buy’ with a ‘Low’ risk outlook.
 
PowerShares KBW Bank Fund (KBWB)
 
This fund tracks the KBW Bank Index and has AUM of $165.6 million. Volume is good as it exchanges more than 131,000 shares a day while expense ratio comes in at 0.35%. The product holds 24 stocks in its basket with largest allocations to 18 big banks that are expected to raise dividends. These collectively make up for 89% of the total assets.
 
From a sector look, banks account for 63% share, followed by financials services (25%), consumer finance (8%) and investment companies (4%). KBWB currently has a dividend yield of 1.46%. The ETF is down 0.5% in the year-to-date time frame but has a Zacks ETF Rank of 2 or ‘Buy’ with a ‘Low’ risk outlook.
 
iShares U.S. Financial Services ETF (IYG)
 
This product follows the Dow Jones U.S. Financial Services Index, holding 109 stocks in its basket. Like its two counterparts, the ETF holds the in-focus eight banking giants in its top 10 holdings, accounting for 50% of total assets. Banks dominate the fund’s portfolio from a sector look while financial services make up for the remainder.
 
The fund has amassed $620.9 million in its asset base and sees moderate average daily volume of over 78,000 shares. It charges a slightly higher fee of 45 bps from investors. The product lost about 1.3% year-to-date and pays 1.07% in dividend yield. IYG currently has a Zacks ETF Rank of 3 or ‘Hold’ with a ‘Low’ risk outlook (read: Mixed Banking Earnings Put These ETFs in Focus).
 
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BANK OF AMER CP (BAC): Free Stock Analysis Report
 
CITIGROUP INC (C): Free Stock Analysis Report
 
ISHARS-US FN SV (IYG): ETF Research Reports
 
PWRSH-KBW BP (KBWB): ETF Research Reports
 
MORGAN STANLEY (MS): Free Stock Analysis Report
 
SPDR-FINL SELS (XLF): ETF Research Reports
 
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