Notes on Banks and Interest Rates

More bank talk! I’ve made a point of saying small banks are very different from big banks. Even beyond that there are different types of banks: conventional banks, investment banks, trust banks, plus a few other oddballs. Only among conventional banks do you find a lot of small and really small companies. There are a few smallish investment banks that are publicly traded and I know of NO small or even medium size trust banks.

Anyway, take a look at the first long term chart below. This is a chart of really big conventional banks. It includes a lot of monsters that cross the lines of conventional banking, but I’m just trying to make a general point. Conventional banks generally, have been down a long time since the Great Recession of 2008/2009. They have vastly underperformed the market. I believe they are on the cusp of a long term break, due to a number of factors.

For one, throughout the period of this chart we have been in a zero or near zero interest rate environment. We’ve been in a market that’s been great for big companies who borrow money, but bad for banks (who lend money.) And not very good for small businesses who can’t borrow money cheaply. Cheap is relative, but suffice to say that S&P 500 companies, most ALL of whom borrow large amounts of money, have been able to borrow very, very cheaply on a relative basis.

Now look at the second chart; this is the yield on 10-year US treasuries. Going from one recession to another, rates have more or less continued to fall. For reference, even 3% on a 10-year treasury is low historically. Recent rates below 1% have only occurred previously during the Great Depression. Yeah, like 80-90 years ago.

The “best” years for the United States were years with strongly “positive yield curves.” That mean short term rates, such as 3-MONTH treasuries, are nicely lower that long term rates like the 10-year. This is coincident with strong and broad economic activity, healthy small businesses, and it is great for conventional banks. (I should also not at this point that the general health of banks and banks stocks is generally coincident with a healthy economy. So, tomato tomato.)

That “tail” we see on the 10-year in the last six months, a steady climb higher, is indicative of change. You can argue how permanent this will be, but in most ways it is hopeful of a return to a normal economic landscape. (I’m not saying the post-Covid period will be back to normal, some things may permanently change because of it, but there is reason to think what emerges is good for most people.)