So my understanding is that a commercial bank is basically an institution that takes in deposits and lends them out to various businesses, and the firm’s shareholders have a given amount of equity in the business. Note I’m not talking about investment banks, S&T etc, just normal retail banking.
In that regard, isn’t a bank then essentially a leveraged fixed income investment vehicle? Furthermore should it be different from a leveraged fixed income CEF except for the fact that it needs to have perpetual liquidity rather than once a day like a MF?
Now the interest rates on deposits is really low, even for CD’s as well giving banks a really low cost of borrowing, so even if you invest deposits in safe securities with a decent spread over the cost, with the great amount of implied leverage that banks have, you could get epic returns right?
From the bank’s perspective? No, this is a terrible environment for “traditional” retail banks. The flatter the yield curve, the harder it is for banks to make money. They could take a bigger bet on duration to work that implied leverage, but that carries obvious risks.
As the Fed keeps longer rates low via things like Operation Twist, traditional banking becomes much less profitable. There’s actually less incentive for the banks to loan money…there’s no spread in it. It’s counterintuitive, but so are most things the Fed does.
Margins shrink as rates get lower. Banks have been deleveraging partially due to new the regulatory environment and economic uncertainty etc.
the new normal would see banks leveraged maybe 10-15x with an ROE of 9-15%.
As with a lot of investments, it depends on how much you pay for the asset. At these levels banks (1-1.2x book) aren’t terribly expensive. I own 3 bank stocks. its been a tough ride indeed but the good banks will do well overtime while the bad ones just whither along…
its not just a fixed income vechile as most major regional banks will see anywhere between 35-50% of their income from fees and other associated charges, which are really profitable.