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Bank cost of equity

I don’t cover banks, but much of my investment portfolio is in bank preferred stocks. I love them. I have done my own valuations on them, but a very important part is estimating what the bank’s cost of preferred stock is to discount the preferred coupon stream.

I have my own way of estimating cost of preferred capital (which includes adjusting for different characteristics of preferred stock), but the hardest thing to pin down is determining the bank’s cost of equity. Using CAPM seems to be a common technique, but I feel like a sucker relying only on that. To supplement CAPM, I’ve estimated growth rates for banks and used them in FCFE and DDM models, along with current equity market valuations and solve for cost of equity to get a market-implied cost of equity. I come up with a blended estimated cost of equity using those different techniques.

Do any of you have any suggestions on better ways to determine a bank’s cost of equity? Is it as easy as just using CAPM? I was just curious given my lack of experience analyzing banks. Thanks.

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I think most banks have some target return on equity of around 10%. This is published somewhere. They adjust capital and scale business sizes to hit this target, so it seems that it is relevant somehow. 

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It’s a lot more complicated than that, unfortunatley.

However, you can assume that the beta is 0.8, by bottom-up method. That’s the best accuracy for calculation ratio you could find.

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I made my last purchase of bank preferreds on March 9th, 2009 and have been holding most ever since. Have not wanted to pay Uncle Sam(or more accurately make somebody else pay Uncle Sam). This thread is a good reminder that I should finally get off the train.

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I’d say 10% is a good rule of thumb. I think this paper has a method for estimating it for community banks. I’m a little unsure if you mean all banks or just money centers when using the term banks.

https://www.google.com/url?sa=t&source=web&rct=j&url=http://www.mch-inc....

I’d agree with 10% being the best answer. Personally I think the biggest benefit of being part of a private equity fund is that you can make a private investment in public equity, which means you can purchase shares in a publicly-traded company outside of a public offering in a stock exchange, just as mentioned here https://dealroom.net/blog/private-equity-investment-vs-investment-banking.