Outlook for BMO ETFs Amid Recent U.S. Bank Downgrades

Aug. 29, 2023


A weakening commercial real estate market, among other factors, has led to several U.S. regional banks receiving downgrades from both Moody’s and Standard & Poor’s, trusted credit rating agencies. Portfolio Manager Alfred Lee shares three potential catalysts for the sector and his outlook for BMO U.S. Banks ETFs.



  • Large U.S. banks are well-positioned to withstand a recession, according to the Fed’s annual stress test results in June1
  • We have seen shares outstanding on all three of our U.S. bank ETFs, showing demand from longer-term investors seeking value
  • The BMO Covered Call US Banks ETF (Ticker: ZWK) allows investors to monetize volatility in the U.S. banking sector through a covered call option overlay

Some U.S. banks get a downgrade, others on watch

U.S. banks remain in the headlines, with Moody’s recently downgrading several of them, placing more on review and assigning others a negative” outlook. Last week, Standard & Poor’s (S&P) reaffirmed these views, downgrading some lenders — particularly regional banks with high exposure to commercial real estate (CRE) exposure.

Moody’s Recent Downgrades on U.S. Banks


Review for Downgrade

Negative Outlook

M&T Bank


Simmons First National

Webster Financial

Bank of New York Mellon

Fifth Third

BOK Financial

U.S. Bancorp

F.N.B. Corp.

Fulton Financial


Citizen Financial

Pinnacle Financial

State Street

Capital One

Old National

Northern Trust

Huntington Bancshares

Prosperity Bancshares


Amarillo National

Regions Financial

Associated Banc-Corp

Cadence Bank

Commerce Bancshares

Ally Financial

Bank OZK

Source: Moody’s, Bloomberg.

The recent downgrade worries add to the default concerns small regional banks faced in March. As we highlighted earlier this year, the U.S. Federal Reserve (Fed)’s rapid tightening of monetary policy put pressure on regional banks’ Held-to-Maturity (HTM) portfolios. The Fed, which responded by backstopping the Federal Deposit Insurance Corporation (FDIC) full-stop and creating the Bank Term Funding Program (BTFP), has helped in alleviating the stress in the sector, as evidenced by the declining prices of credit default swaps (CDS) on some lenders since that period.

The Fed — which released its annual stress test results in June — showed all 23 participating U.S. banks had passed. The central bank uses this test to assess whether a bank can withstand a severe global recession. Parameters include having enough capital on hand to absorb losses and continue lending if unemployment hits 10% and the stock market plunges 45%. The stress test is revised annually to ensure it applies to the current environment, and this year includes a 40% drop in CRE. It should be noted, however, that the test comprises mostly larger to mid-sized lenders and would not capture unforeseen events, such as the 2020 COVID-19 pandemic. 

Despite the concerns, we have seen shares outstanding on all three of our U.S. bank ETFs: BMO Equal Weight US Banks Index ETF (Ticker: ZBK), BMO Equal Weight US Banks Hedged to CAD Index ETF (Ticker: ZUB) and the BMO Covered Call US Banks ETF (Ticker: ZWK), illustrating demand from longer-term investors seeking value, with the current price-to-earnings (P/E) ratio on ZBK/ZUB at 5.56x and ZWK at 8.25x, as of August 25, 2023.2





Shares Outstanding Increase

BMO Equal Weight US Banks Index ETF





BMO Equal Weight US Banks Hedged to CAD Index ETF 





BMO Covered Call US Banks ETF





Source: Bloomberg, BMO Global Asset Management Inc. 

Three potential catalysts

  1. Normalization of the yield curve. The yield curve, which has remained inverted since early July 2022, tends to signal a slowing economy. In recent weeks, longer rates have moved higher, which can be interpreted as the yield curve moving toward normalization. While recent moves in the yield curve have been more of a bear steepener, its likely shorter-term rates will not move lower until 2024, when the Fed becomes more comfortable that inflation has been tamed. A normalized yield curve would signal a more stable economy and create a more favourable economic backdrop for lenders.
  2. Repurposing of CRE. Working From Home (WFH) has become a trend that has persisted after the COVID-19 pandemic. As a result, capacity rates in office buildings have remained low, which has been an overhang on many of the regional lenders. However, an emerging trend is adaptive reuse,” or repurposing commercial real estate. This potentially removes some of the glut of supply in office real estate over the long term.
  3. Loan losses are less than anticipated. U.S. banks have set aside provisions in anticipation of loan losses. The labour market, however, has proved to be more resilient than expected despite the Fed’s efforts to slow the economy. Borrowers that took out long-term mortgages or refinanced at lower rates have been reluctant to move, and the housing market has not fallen as projected.

Outlook for our U.S. bank ETFs

Unlike in 2009 and 2020, we don’t anticipate a rapid recovery in U.S. bank stocks, as they were driven by quantitative easing and aggressive cuts to the overnight rate at the time. Today, we have the opposite policies, with quantitative tightening and higher interest rates expected to be more resilient. 

However, the low valuations of ZBK/ZUB and ZWK may make it appealing for longer-term investors. The net dividend yield is 3.4% on ZBK/ZUB and 11.7% on ZWK, as of August 25, 2023,2 which is supplemented through the covered call option overlay.

While we see potential volatility in the sector, the Fed’s BTFP backstop measures and support of the FDIC have, so far, proven to provide some stability to the regional banks. However, we prefer ZWK for exposure to the space, as it allows investors to monetize volatility. The option overlay process is conservative, covering only 40% of the portfolio and utilizing out-of-the-money options, so investors still participate in some of the upside should the market rally. 


Advisor Use Only. 

Commissions, management fees and expenses all may be associated with investments in exchange traded funds. Please read the ETF Facts or prospectus of the BMO ETFs before investing. The indicated rates of return are the historical annual compounded total returns including changes in unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder that would have reduced returns. Exchange traded funds are not guaranteed, their values change frequently and past performance may not be repeated. 

For a summary of the risks of an investment in the BMO ETFs, please see the specific risks set out in the BMO ETF’s prospectus. BMO ETFs trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/​or elimination.

BMO ETFs are managed by BMO Asset Management Inc., which is an investment fund manager and a portfolio manager, and a separate legal entity from Bank of Montreal. 

Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.

The viewpoints expressed by the Portfolio Manager represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time without any kind of notice. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. This communication is intended for informational purposes only.

The communication is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Particular investments and/​or trading strategies should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.

BMO Global Asset Management is a brand name under which BMO Asset Management Inc. and BMO Investments Inc. operate.

®/TM Registered trademarks/​trademark of Bank of Montreal, used under licence.