Two years ago, then Wells Fargo (NYSE:WFC) Chief Financial Officer Tim Sloan was quoted as saying higher interest rates are good for Wells Fargo, commenting "The current backup in rates we think is attractive and will allow us to invest." The same sentiment is being echoed all over Wall Street today, and Mr. Sloan's views are shared by many. As someone who has spent more than a few decades in interest rate risk management, I can say that the feeling that higher rates are good for banks is not shared by all. This note presents some lessons from history that show higher interest rates over the last few decades have been harmful to bank stock prices. A companion piece still in the works will present the analytics that confirm the historical facts we show here for 9 major bank holding companies.
About a decade ago, I was at a meeting of the risk managers of most of the largest bank holding companies in the United States and Canada. Whether or not higher rates were good for bank stocks was the topic of the day, and opinions varied widely. I much prefer facts to opinions, because facts are usually in short supply, so I undertook a study of the issue with the encouragement of the group. We looked at the stock prices of the 100 largest U.S. bank holding companies quarterly over a 10-year period. We asked the question, "When interest rates go up, what happens to the stock price of each of these 100 bank holding companies?" The answer for the median of the 100 banking firms was that a 1 percentage point rise in rates lowered the stock price by one percent. Silicon Valley Bank (SVB) was a notable exception, with a stock price boosted by in the money options of technology firms who had been borrowers from the bank.
Our objective in this note is much more modest. We take the longest daily stock price history we can find on 9 large bank holding companies:
Bank of America Corporation (NYSE:BAC)
Bank of New York Mellon (NYSE:BK)
Citigroup Inc. (NYSE:C)
JPMorgan Chase & Co. (NYSE:JPM)
State Street (NYSE:STT)
Sun Trust (NYSE:STI)
U.S. Bancorp (NYSE:USB)
Wells Fargo & Company
We combine the stock price history with a daily time series on U.S. Treasury yields from the U.S. Department of the Treasury. We focus on the 10 year U.S. Treasury yield in this note. Our conclusion is strong: both including and excluding data from the heart of the credit crisis, higher interest rates have a strong negative correlation with bank stock prices. On average, when interest rates go up, bank stock prices go down. This is consistent with the financial analysis that we will present in part 2 of this series and with the results of the statistical study done a decade ago. We now review the results for each of the banks in turn.
Bank of America Corporation
For each of the bank holding companies, we use the adjusted closing stock price provided by Yahoo Finance. The adjustments include the impact of dividends and stock splits. We use the longest daily time series available. The history of the adjusted Bank of America Corporation stock price and the 10 year Treasury yield are shown here from 1986 onward.
The devastating impact of the credit crisis on the Bank of America stock price is obvious, so we present results for both the full sample and for the full sample less the dates between September 12, 2008 (just before the fall of Lehman Brothers) and April 1, 2009. The scatter diagram of stock price versus the 10-year Treasury is shown here:
The black line is a simple smoothed line that connects the median levels of the stock price and the 10-year Treasury yield over the full sample.
Over the full sample, the Bank of America stock price has a negative correlation with the 10-year U.S. Treasury yield: -43.10%. Excluding the credit crisis dates, the correlation is similar: -44.53%. A simple linear regression of the stock price level on the 10-year U.S. Treasury yield level shows the strong negative impact of interest rates on the stock price. See Appendix A for details.
Bank of New York Mellon
The daily plot of Bank of New York Mellon stock price versus U.S. Treasuries starts in 1973:
The negative correlation of stock price and Treasury yields is even more starkly apparent than in the case of Bank of America. The scatter plot shows the negative correlation very clearly:
The correlation between stock price and the U.S. Treasury yield is strongly negative over the full sample: -76.10%. Excluding the credit crisis, the correlation is -75.97%.
We now turn to BB&T, whose daily history begins in 1990. The negative correlation between stock price and Treasury yields is quite clear:
The scatter plot is even more dramatic in making the point that correlation over the full sample is strongly negative: -82.20%. Excluding the credit crisis dates, the correlation is -83.44%.
The daily history for Citigroup Inc. starts in 1977 and again shows the dramatic impact of the credit crisis on stock price clearly:
The scatter plot shows a humped result, but the correlation over the full sample is still strongly negative: -42.83%. Excluding the credit crisis dates, the correlation is -43.78%.
JPMorgan Chase & Co.
The results for JPMorgan Chase are given beginning in 1983. The negative correlation between stock price and the level of interest rates is again very clear.
The negative correlation is shown dramatically in the scatter diagram. The full sample correlation of stock price and U.S. Treasury levels is -81.70% for the full sample and -82.31% excluding the credit crisis dates.
The daily history for State Street begins in 1986. The negative correlation between the 10-year U.S. Treasury yield and the State Street stock price is crystal clear.
The strong negative correlation shown in the scatter diagram is -80.72% for the full sample and -81.75% excluding the credit crisis dates.
Turning to Sun Trust, the daily history begins in late 1987. A sharp drop in stock price during the credit crisis is not enough to mask the strong negative correlation between stock price and U.S. Treasury levels.
While there is a hump in the spline in the scatter diagram, the negative correlation is -45.50% for the full sample and -47.45% excluding the credit crisis dates.
The daily history beginning in 1987 shows that U.S. Bancorp was relatively unaffected by the credit crisis, which makes the negative relationship between the U.S. Treasury 10-year yield and stock price quite transparent.
The negative correlation in the scatter diagram is very dramatic. The correlation for the full sample is -86.31%, and excluding the credit crisis dates, the adjusted correlation is 87.25%.
Wells Fargo & Company
We conclude with the daily history of Wells Fargo & Co., which begins in 1972. The negative correlation between stock price and interest rates is obvious.
The scatter diagram showing the negative correlation is quite stark. Over the full sample, the correlation is -78.37%. For the sample excluding the credit crisis dates, the correlation is -78.44%.
The simple linear regression relating stock price level to the 10-year U.S. Treasury yield for Wells Fargo & Co. is equally powerful. It is given in Appendix A.
For all 9 bank holding companies' daily histories, stock prices and the level of the 10-year U.S. Treasury yield have a strong negative correlation. When interest rates go up, stock prices go down. The correlation ranges from negative 40% to negative 90%. Those who argue that a rise in rates is good for bank stock prices have a difficult case to make. We explain why using simple financial analysis in the next installment of this series.
Simple Linear Regression Linking Stock Price Level and U.S. Treasury 10-Year Yield
The simple linear regression results for the full sample for Wells Fargo & Co. show that the level of interest rates is very significant in determining the stock price and that higher rates lower the stock price:
Over 10,739 observations, the U.S. Treasury 10-year yield is highly significant and a rise in Treasury yields is consistent with a fall in stock prices. The same regression, excluding the heart of the credit crisis (those dates between September 12, 2008 and April 1, 2009) gives similar results, as shown here:
The regression results for the other 8 bank holding companies are very similar.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.