Bank Valuation

Financial Issues, Valuation

Implications

Andrew K. Gibbs, CFA, CPA/ABV

Mercer Capital
gibbsa@mercercapital.com | 901.685.2120

#AICPAfvs
Outline
Introduction
! Current Industry Issues Affecting Bank Financial Analysis

Current Valuation Issues

! Asset Approach
! Guideline Company Method
! Guideline Transactions Method
! Discounted Cash Flow Method
! Financial Assets & Liabilities

#AICPAfvs
Current Industry Issues

#AICPAfvs
1. Overview

! Sector overview – then vs. now

! Bank financial analysis is an exercise in risk
assessment and measurement
1.  Credit risk
2.  Interest rate risk
3.  Liquidity risk
! Other Issues
4.  Capital
5.  Holding company/subsidiary relationship
6.  Regulation

#AICPAfvs
Sector Overview – Then vs. Now
Assets > $10B Assets $3B - $10B Assets $500M - $1B
2006 2013 2006 2013 2006 2013
Pre-Tax ROA 1.83% 1.40% 1.73% 1.38% 1.48% 1.08%
ROA 1.21% 0.94% 1.12% 1.05% 1.02% 0.80%
ROE 14.0% 8.3% 12.4% 9.0% 11.4% 7.7%
ROTE (~) 20.5% 11.3% 16.1% 11.5% 12.9% 9.4%
Tangible Common / Tang Assets 5.9% 8.3% 7.0% 9.1% 7.9% 8.5%

Net Interest Margin 3.41% 3.17% 3.87% 3.57% 4.02% 3.61%

NIM less Net Charge-Offs 3.18% 2.72% 3.72% 3.28% 3.91% 3.28%
Fee Income / Revenue 36.4% 35.1% 24.6% 25.5% 19.4% 20.7%
Efficiency Ratio 60.9% 67.6% 61.2% 68.5% 66.5% 74.1%

Loans / Assets 62.6% 60.2% 67.6% 64.7% 70.8% 63.9%

NPAs+ORE / Loans+ORE 0.57% 1.42% 0.49% 1.97% 0.54% 2.38%
Net Charge-Offs / Avg Loans 0.23% 0.45% 0.15% 0.29% 0.11% 0.33%
Loan Loss Reserve / Loans 1.11% 1.41% 1.23% 1.47% 1.17% 1.59%

Source:  FFIEC  Bank  Holding  Company  Performance  Report  Peer  Data  

1H14  returns  are  comparable  to  2013  –  lower  credit  and  op  expenses  have  offset  lower  NIMs  and  mortgage  banking  income  

#AICPAfvs
Sector Overview – Relative ROE

Industry ROE Less 10-Year UST ("Spread") LTM 1 Yr Avg Current Current
84-89 90-99 00-07 08-13 84-13 ROE 10Y Yld Spread v. 84-13
Assets > $10B 1.7% 7.4% 9.1% 4.6% 7.1% 9.4% 2.6% 6.8% -0.3%

Assets $1-10B -1.7% 7.6% 8.3% 2.8% 5.9% 8.9% 2.6% 6.3% 0.4%

Assets $100M-$1B -4.6% 5.7% 6.6% 1.7% 5.0% 8.4% 2.6% 5.8% 0.8%

Assets < $100M -2.5% 3.8% 3.3% 1.0% 2.4% 6.5% 2.6% 3.8% 1.4%
All Insured Institutions -3.0% 7.1% 8.4% 6.6% 6.6% 9.3% 2.6% 6.6% 0.0%

Source:  FDIC  

! Typical “spread” to 10-year US Treasury 6% – 7%

! Latest 12 month (LTM) ROE through 2Q14 within the
historical range
! But, increasing capital requirements and NIM pressure
from very low rates may cause some narrowing

#AICPAfvs
Community Banks
Recent Industry Trends
Current Challenges
! Yields under NIM compression via Fed’s zero interest rate policy (ZIRP)

! Loan demand still lagging in many regions

! Operating leverage is tough to achieve given pressure on revenues and rising

compliance expenses

! Regulatory expectations regarding higher capital ratios (and more common

equity within the capital structure)

#AICPAfvs
 1. Asset Quality
!   Median nonperforming asset ratios remain elevated
due to legacy assets
!   Weaker underwriting of new loans?

Source:    Mercer  Capital  research,  SNL  Financial  

Peer  group  includes  approximately  3,900  banks  with  assets  between  $100  million  and  $5  billion  
OREO  =  Other  Real  Estate  Owned  =  Foreclosed  Property  

#AICPAfvs
1. Asset Quality
! What trends would indicate higher credit risk?
•  Level of and trend in non-performing assets
•  Composition of the portfolio (e.g., level of construction and development loans;
type of C&D loans, such as land vs. finished houses)
•  Historical growth rates
•  Weak market
•  High loan yields
•  Out-of-market loans, particularly purchased participations
•  Large exposures to one borrower
•  Experience of management
•  Off balance sheet exposure (mortgage repurchase claims, for instance)
•  Low charge-offs in relation to level of problem loans
•  Less onerous loan terms (interest only versus amortizing loans, for example)

#AICPAfvs
1. Analyzing Asset Quality

! Loan Loss Reserve Adequacy

•  Reserve / Loan Ratio
-  Effect: Declining ratio suggests that the bank’s loan loss provision is not keeping up
with growth or loan losses. Future income could be affected as provisions are
recorded to account for previous growth
•  Reserve / Non-Performing Assets
-  Effect: Declining ratio suggests that credit risk in the portfolio is mounting and reserve
may not be adequate to cover potential losses
•  Directional consistency
-  Expect that reserve should increase along with problem loans
•  Composition of portfolio
•  Gut instinct – impression of management, markets in which the bank operates,
product types emphasized
•  Migration to Current Expected Credit Loss (CECL) model for determining
reserves in the offing

#AICPAfvs
1. Asset Quality – Valuation Concerns
! Assume that you believe the reserves are appropriate and
management has a good grasp of the portfolio. How should you
reflect asset quality issues in an appraisal?
•  Locate a group of guideline companies/transactions that share the
characteristics of the subject bank
•  Factor the asset quality issues into the cash flows of a discounted cash flow
analysis or adjust the discount rate
! Assume, on the other hand, that you don’t believe the reserves are
appropriate or that credit risk is greater than management believes.
How should you deal with this issue?
•  Adjust the loan loss reserve for the assumed deficiency
•  Adjust the guideline company/transaction multiples
•  Perform some type of scenario analysis in a DCF with higher credit loss
scenarios

#AICPAfvs
2. Interest Rate Risk
! Interest rate risk represents the impact on revenue, earnings,
or equity attributable to changing interest rates
! Community banks’ net interest margins generally have been
under pressure but NIMs appear have stabilized more recently
•  Funding cost leverage is waning
-  Limited opportunities to reduce rates on non-maturity deposits and declining spreads between rates
on new CDs and maturing CDs
-  Loan competition is aggressive; significant pressure on community banks to match longer term, fixed
rate loan pricing offered by larger banks
-  Obtaining yield in the bond market is challenging without going out on the yield curve

! In short, Fed’s zero interest rate policy will be a challenge for

banks
•  Most at risk appear to be banks with larger commercial loan portfolios

#AICPAfvs
2. Interest Rate Risk – Rising Rates Always
Around the Corner

Source:  WSJ  and  Bloomberg  

#AICPAfvs
2. Interest Rate Risk

Source:    Mercer  Capital  research,  SNL  Financial  

Peer  group  includes  approximately  3,900  banks  with  assets  between  $100  million  and  $5  billion  
Net  Interest  Margin  =  Net  Interest  Income  /  Average  Earning  Assets  (Yield  on  Earning  Assets  –  Cost  of  Earning  Assets)  

#AICPAfvs
3. Liquidity Risk
! Liquidity risk represents the ability of banks to satisfy
obligations to depositors or other creditors
•  Usually appears in stressed environments or in conjunction with other risks
•  Greater pressure from regulators to hold on balance sheet liquidity
•  New liquidity rules limited to larger banks but may eventually trickle down

#AICPAfvs
 4. Capital
!   By regulation, banks need to maintain certain ratios of “capital”
to assets
•  Currently, “Tier 1 Capital” is basically defined as shareholders’ equity,
minus intangible assets, plus/minus the loss/gain on available-for-sale
securities
-  Also can include preferred stock and trust preferred securities (subject to certain limits) in
holding company’s Tier 1 capital
-  TARP Capital Purchase Program preferred stock is Tier 1
•  “Tier 2” capital includes the loan loss reserve and subordinated debt

Capital Alternatives
- Higher Cost
- Lower Cost
- Less favorable Tax
- Better Tax Treatment
Trust Preferred Straight Preferred Convertible Treatment
- Less Dilution Subordinated Debt Common Stock
Securities Stock Preferred Stock - More Dilution
- Less Advantageous
- More Advantageous
Capital Treatment
Capital Treatment

#AICPAfvs
4. Capital

! Capital standards will change significantly

•  Transition to Basel III standards for banks and holding companies with more
than $500 million in assets
•  Introduction of a new capital measure – Tier 1 common ratio
•  Significant tightening of rules regarding instruments that qualify as capital; hybrid
instruments, such as trust preferred securities, to be phased out
•  Less favorable treatment of items such as mortgage servicing rights
•  New rules regarding the calculation of risk-weighted assets
•  New capital buffer and impact on dividends and bonuses
•  Implications
-  Need to augment capital to comply with Tier 1 common metric
-  Impact on return on equity

#AICPAfvs
5. Holding Company/
Sub. Relationship
! Relationship between the bank and holding company is important
! A bank holding company can appear reasonably stable from a
consolidated perspective but have underlying financial challenges
•  Given legal structure between bank and holding company, bank is the primary source of
funds for the holding company (absent the sale of equity/debt by the holding company)
•  Holding company, in turn, has liquidity needs of its own (debt service, operating expenses,
taxes)
•  Limitation may exist at the bank that prevents funds from being transferred to the parent
! It’s important to review the sources and uses of funds at the parent
company level

#AICPAfvs
6. Regulation
! Regulators have become much more assertive
! Significant focus now on compliance issues
•  Bank Secrecy Act, Anti-Money Laundering, Mortgage Origination and Servicing, etc.
! Valuation impact can be more difficult to quantify
•  Most banks spending significantly more on compliance activities than five years ago
•  Potential restrictions on M&A, adverse scores on regulatory exams

#AICPAfvs
Valuation Structure

#AICPAfvs
Organizational Structure
Bank Holding Company Balance Sheet
!  Most banks are wholly-
Line of Credit ($1,000)
owned subsidiaries of Trust Preferred
Investment in the
bank holding companies. Bank (equal to the Securities ($2,000)
Most valuation bank's equity)
Common Stock
engagements, in turn, ($10,000)
($7,000)
involve valuing the
common stock of the bank
holding company Bank Holding Company Income Statement

!  In the adjacent example,

LOC Interest ($60)
the valuation analyst would Trust Preferred Interest
use shareholders’ equity of Bank Net Income ($160)
$7,000 and net income of ($1,000)
Net Income
$780 in the valuation ($780)
analysis

#AICPAfvs
 Common Valuation Metrics
! Bank valuation analyses use multiples based on both income
statement and balance sheet metrics

Income  Statement   Balance  Sheet  

»  Historical  net  income   »  Stated  (GAAP)  shareholders’  equity  

»  Forward  net  income   »  Tangible  shareholders’  equity  (stated  

shareholders’  equity  less  acquisi`on-­‐
»  Pre-­‐tax,  pre-­‐provision  net  income  (net   related  intangible  assets)  
interest  income,  plus  non-­‐interest  income,  
minus  non-­‐interest  expense)   »  Deposits  

»  Core  deposits  (variously  defined,  but  can  

exclude  CDs  >  $100,000,  CDs  >  $250,000,  
and/or  brokered  deposits)  

»  Assets  

#AICPAfvs
Valuation Perspective

! Public Market Value ! Acquisition Value

!   Core profitability !   Core profitability

!   Growth record and prospects … !   Expense saves (who gets
EPS, TBVPS, DPS and revenue credit?)
!   Organic vs. acquisition growth !   Revenue synergies (reality?)
!   Credit quality !   Number of bidders
!   Capital !   Alternative targets for bidders
!   Risk perceptions !   What a buyer can afford
!   Liquidity of shares !   Stated multiples to seller vs.
!   Location pro-forma multiples to buyer (P/
E with expense savings, P/TBV
after balance sheet marks)

#AICPAfvs
Earning Power Analysis

! How does your assessment of the income statement and

balance sheet affect your analysis?
! Scenario 1: Assume that the bank is profitable
1.  Adjust the income statement and balance sheet
2.  Use balance sheet-based measures as another indicator of value
! Scenario 2: Assume that the bank’s earnings are depressed
or it is operating at a loss
1.  Adjust the income statement and balance sheet
2.  Estimate earning power via a normalized return on assets or equity
3.  Emphasize balance sheet-based measures over income statement
measures
4.  Discounted cash flow analysis

#AICPAfvs
 Adjust the Financial Statements

! Common Adjustments:
Income  Statement   Balance  Sheet  
»  Eliminate  non-­‐recurring  gains  and  losses   »  Adjust  to  reflect  market  values  of  assets  
(e.g.,  securi`es)  
§  Securi`es  carried  at  cost  
»  Recognize  normalized  loan  loss  provision     §  Investments  in  other  companies  carried  at  
cost  or  equity  
»  Normalize  tax  rate  
»  Recognize  es`mated  cost  of  segling  
»  Purchase  accoun`ng  amor`za`on  
con`ngent  liabili`es  
»  Life  insurance  proceeds  
»  Normalize  loan  loss  reserve  

»  Adjust  intangible  assets  

#AICPAfvs
Estimate Normalized ROA/ROE

! Sometimes, a bank has a (really) bad year but otherwise has a

profitable history. You can use historical returns to estimate earning
power
•  Danger is glossing over the exposures arising from the current environment
•  Past returns may not be indicative of future returns
2014 2013 2012 2011 2010 2009
Average Assets $277,372 $254,470 $231,336 $226,800 $210,000 $200,000
Average Equity $23,148 $25,228 $22,785 $20,518 $18,205 $16,000

Net Income ($2,080) $2,443 $2,267 $2,313 $2,205 $2,000

Return on Average Assets -0.75% 0.96% 0.98% 1.02% 1.05% 1.00%

Return on Average Equity -8.99% 9.68% 9.95% 11.27% 12.11% 12.50%

Average Return on Assets 1.00% <> excluding 2014

Average Return on Equity 11.10% <> excluding 2014

ROA ROE
Balance Sheet Parameter (2011) $277,372 $23,148
x Normalized ROA / ROE 1.00% 11.10%
= Estimated Earning Power $2,779 $2,570

#AICPAfvs
Asset Approach

#AICPAfvs
Asset Approach

! Common adjustments
•  Assets
-  Loans (interest and credit mark)
-  Other real estate owned
-  Securities carried as held-to-maturity
-  Unrecognized intangible assets (core deposit intangible asset)
•  Liabilities
-  Certificates of deposit
-  Fixed term borrowings (FHLB advances)
-  Borrowings with wider/narrower credit spreads than at issuance (e.g., trust
preferreds)
•  Equity
-  Preferred stock

#AICPAfvs
Guideline Company
Method

#AICPAfvs
Guideline Public Co. Method

! Factors to consider in selecting guideline public

companies
•  Entity type (bank vs. thrift)
•  Size
•  Profitability
•  Location
•  Non-performing assets
•  Capital structure (TARP vs. non-TARP, capital ratios)

#AICPAfvs
Sector Overview – Total Return

Source:  SNL  Financial  

#AICPAfvs
Trading Multiples: Asset Size Sort
!   Smaller banks have traded at discounts to larger banks; reflects (a)
liquidity, (b) more limited access to capital, (c) growth
opportunities, such as industry consolidation
Non-
Performing
Assets /
Price / Return on Tangible
Price / LTM Tangible Dividend Total Tangible Equity + Number of
Return on Tangible Equity > 10% EPS Book Value Yield Assets Equity Reserves Banks
Assets $5 Billion - $10 Billion 14.9 188% 2.38% 6,789,173 13.3% 13.81% 27
Assets $1 Billion - $5 Billion 13.2 151% 2.50% 2,153,051 12.4% 10.42% 73
Assets < $1 Billion 11.0 120% 2.70% 722,037 11.5% 18.03% 24

Return on Tangible Equity 0% - 10%

Assets $5 Billion - $10 Billion 17.8 134% 2.17% 6,311,374 8.3% 13.29% 11
Assets $1 Billion - $5 Billion 17.3 132% 1.35% 1,903,342 7.9% 15.52% 68
Assets < $1 Billion 15.7 103% 1.44% 630,428 6.8% 13.88% 52

Return on Tangible Equity < 0%

Assets $5 Billion - $10 Billion nm nm nm nm nm nm 0
Assets $1 Billion - $5 Billion nm 140% 0.00% 1,064,853 -4.0% 19.19% 9
Assets < $1 Billion nm 160% 0.00% 468,348 -1.7% 81.04% 6

Notes:
Return on stated equity used when ROTE unavailable; price/BV used when price/TBV unavailable
Table includes 270 publicly traded banks with assets < $10 billion; market data as of October 13, 2014; financial data as of June 30, 2014
Trading Multiples: Profitability Sort
! Price/tangible book value multiples correlated with
return on equity
•  Multiples for unprofitable banks reflect entity-specific factors,
such as potential deferred tax asset valuation allowance
reversals
Non-
Performing
Assets /
Return on Price / Tangible
Tangible Tangible Price / LTM Dividend Total Equity + Number of
Equity Book Value EPS Yield Assets Reserves Banks
Return on Tangible Equity > 15% 16.7% 202% 13.7 2.49% 3,630,673 10.30% 22
Return on Tangible Equity 10% - 15% 11.8% 148% 13.2 2.50% 1,877,033 12.23% 102
Return on Tangible Equity 5% - 10% 8.1% 124% 16.8 1.56% 1,389,712 13.95% 105
Return on Tangible Equity 0% - 5% 3.7% 90% 27.9 1.01% 916,665 13.17% 26
Return on Equity < 0% -2.0% 152% nm 0.00% 1,012,685 28.99% 15

Notes:
Return on stated equity used when ROTE unavailable; price/BV used when price/TBV unavailable
Table includes 270 publicly traded banks with assets < $10 billion; market data as of October 13, 2014; financial data as of June 30, 2014

#AICPAfvs
GPCM - Public Market Historical Trends

Price/Earnings and Price/Book Value Multiples

Banks with Assets of $500 Million - $5 Billion & Return on Tang. Equity > 10%

20.0 3.00

18.0

16.0 2.40

Price/Tangible Book Value Multiple

14.0
Price/Earnings Multiple

12.0 1.80

10.0

8.0 1.20

6.0

2004 - 2013 4.0 0.60

Medians:
P/E: 13.24x 2.0
P/TBV: 1.68x
0.0 0.00
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Price / Earnings 17.6 15.4 16.5 13.1 13.3 13.0 12.1 11.0 10.6 13.5
Price / Tang. Book Value 2.57 2.37 2.37 1.74 1.73 1.57 1.58 1.23 1.27 1.62

Source: Mercer Capital Research, SNL Financial

#AICPAfvs
Guideline Public Co. Method

! After you have identified a group of comparable companies,

common valuation metrics are LTM earnings, forward
earnings (one or two years), stated book value, and tangible
book value
! Appraisers often adjust public company multiples for
differences between the public companies and the subject
company. For example:
•  Size (banks appraisers value are often smaller than the smallest
publicly traded banks)
•  Location (appraisers see more banks in rural areas)
•  Growth (banks in communities without much population or economic
growth may have more limited growth prospects than the public
companies)

#AICPAfvs
Guideline Public Co. Method
! Adjustments for differences in the capital structure of the publicly
traded banks and the subject bank may also be necessary
•  For example, the subject banks may have tangible equity equal to 10% of
assets; comparable ratio is 8% for the public banks
•  “Excess equity is valued dollar-for-dollar”

Capitalization of Tangible Book Value (Shareholders' Equity)

Tangible Book Value $10,000,000
Tangible Assets $100,000,000
Normalized Tangible Equity/Tangible Assets Ratio 8.00%
Normalized Tangible Equity 8,000,000
Excess Tangible Equity $2,000,000

Normalized Tangible Equity $8,000,000

x Price/Tangible Book Value Ratio 1.25
= Capitalized Normalized Equity $10,000,000
+ Excess Tangible Equity 2,000,000
= Capitalized Tangible Book Value $12,000,000

INDICATED VALUE: GUIDELINE PUBLIC COMPANY METHOD

- CAPITALIZED TANGIBLE BOOK VALUE $12,000,000

#AICPAfvs
Guideline Transactions
Method

#AICPAfvs
National Bank M&A History

Source:  SNL  Financial  

#AICPAfvs
National M&A Pricing Multiples

Source:  SNL  Financial  

#AICPAfvs
Guideline Transactions Method

»  Perhaps  easier  to  apply  to  a  small  bank  than  a  larger  bank  
due  to  the  fact  that  most  transac`on  ac`vity  involves  
smaller  banks  
»  The  guideline  transac`ons  can  ohen  be  tailored  rela`vely  
closely  to  the  subject  bank’s  loca`on,  size,  performance,  etc.  
§  Trade-­‐off  is  the  `meliness  of  data.    How  far  back  in  `me  should  you  
go?  
»  Probably  depends  on  the  M&A  markets  at  large  

#AICPAfvs
Guideline Transactions Method

»  Search  for  comparable  transac`ons  based  on:  

§  Size  
§  Profitability  
§  Loca`on  (e.g.,  Texas)  
§  Metropolitan  vs.  rural  loca`on  (e.g.,  rural  Texas  vs.  Dallas,  Houston,  etc.)  

»  Can  derive  indica`ons  of  value  using:  

§  Net  income  
§  Book  value  and  tangible  book  value  
§  Assets  
§  Core  deposits  

#AICPAfvs
Guideline Transactions Method

»  Difficul`es  have  arisen  in  applying  the  guideline  transac`ons  

method  
§  Have  the  same  issues  in  determining  earning  power  as  in  the  
guideline  public  company  analysis  
§  More  deals  involve  banks  in  distress  with  resultant  difficulty  in  
determining  the  true  value  of  the  transac`on  (e.g.,  con`ngent  
payments)  

#AICPAfvs
Guideline Transactions Method

»  Example  applica`on  of  the  guideline  transac`on  method:  

Tangible Core
Net Income Book Value Deposits
Financial Metric $1,000,000 $10,000,000 $100,000,000
x Multiple 15.00 1.25 4.00%
= Product $15,000,000 $12,500,000 $4,000,000
+ Tangible Book Value na na 10,000,000
= Indicated Value $15,000,000 $12,500,000 $14,000,000

Note:    Core  deposits  are  defined  by  SNL  as  total  deposits,  less  CDs  
over  $100,000,  less  foreign  deposits  

#AICPAfvs
Discounted Cash Flow
Method

#AICPAfvs
“CF” – Cash Flow Component
! Since cash is fungible in a bank, the cash flow
measure incorporated into a DCF model differs from
that used in a non-financial company
•  Most analysts use some form of dividends or “distributable
tangible equity” in a DCF model

! Valuing a minority interest

•  Minority investors have no ability to compel the bank to manage to an
optimal capital structure. Therefore, the cash flows discounted could
be based on the bank’s historical and/or expected dividend policy

#AICPAfvs
“CF” – Cash Flow Component
! Valuing a controlling interest
•  A control investor has the ability to manage to an optimal capital structure
•  Therefore, the analyst can estimate the “distributable tangible equity” that the
bank generates, based on a target capital structure or regulatory capital norms
-  In other words, the amount of earnings above the amount necessary to remain in
compliance with regulatory capital standards can be distributed
-  What is the “well capitalized” level now?

! To derive a controlling interest value, the appraiser can adjust

the projections for expected synergies
•  Ordinarily, “synergies” take the form of reduced operating expenses. Expected
expense reductions are reported by SNL Financial

#AICPAfvs
“CF” – Cash Flow Component
! Projections can involve varying degrees of
complexity
•  A projection of asset growth and a projected return on assets
•  A projection of pre-tax, pre-provision net income (i.e., net interest
income, plus non-interest income, minus non-interest operating
expenses), coupled with a projection of expected loan losses
•  A full projection of a balance sheet and income statement

#AICPAfvs
“CF” – Cash Flow Component
! Projection “risks”
•  Projecting an income statement without a balance sheet
-  Remember that balance sheets drive income statements for financial institutions

•  Not presenting a roll-forward of the loan loss reserve

-  Risk of ending up with unexpected outcomes, such as negative charge-offs (i.e., a net
recovery of prior charge-offs)

•  Not evaluating the flow of funds between the bank and holding
company
-  For example, projecting cash expenses or distributions at the holding company when
the bank cannot pay dividends to the holding company

#AICPAfvs
 “CF” – Projections
! We often prepare the projections at the subsidiary
bank level and then roll them up to the holding
company

Projected Financial Statements

Consolidated Net Income ($000) 2013 2014 2015 2016 2017 2018
Bank Net Income $728 $656 $991 $1,115 $1,247 $1,386
1) Interest Expense -- Holding Co. Debt 0 0 0 0 0 0
2) Other Holding Company Expense 0 0 0 0 0 0
3) Interest Expense -- Trust Preferred 0 (140) (140) (140) (140) (140)
4) Income Tax (Expense) / Benefit 38.3% 0 54 54 54 54 54
CONSOLIDATED NET INCOME $728 $570 $905 $1,029 $1,160 $1,300

Projected Shareholder Dividend Payout Ratio 12.00% 12.00% 24.00% 35.00% 46.50%
Projected Dividends Paid to Shareholders $68 $109 $247 $406 $605

#AICPAfvs
 “CF” – Projections
! Cash remaining at holding company level is
distributed to shareholders
Projected Financial Statements
Holding Company Cash Flow 2014 2015 2016 2017 2018
Cash Receipts:
Dividends from Bank $164 $198 $334 $499 $693
Income Tax Benefit 54 54 54 54 54
Trust Preferred Issuance 0 0 0 0 0
Additional Borrowings 0 0 0 0 0
Total Inflows $218 $252 $388 $552 $747

Cash Disbursements:
Holding Company Expenses $140 $140 $140 $140 $140
Injections into Bank Subsidiary 0 0 0 0 0
Share Repurchase 0 0 0 0 0
Common Dividends Paid 68 109 247 406 605
Total Outflows $208 $249 $387 $546 $745

REMAINING CASH FLOW AVAILABLE 9 3 1 6 2

#AICPAfvs
Discount Rate
! Do you use a cost of equity or a weighted average
cost of capital for a bank?
•  Generally, analysts use a cost of equity
•  A WACC constructed with the cost of deposits as an input
makes little sense (cost of deposits does not increase along
with leverage)
•  However, a WACC incorporating the holding company’s cost of
borrowings (such as the cost of its trust preferred securities)
makes some theoretical sense
-  Effectively, the analyst is assuming that the bank’s regulatory
capital requirements are funded with some mixture of debt and
equity and the cost of such capital can be captured in a WACC

#AICPAfvs
Valuation of Financial
Assets & Liabilities

#AICPAfvs
Discount Rate
! Assets and liabilities commonly valued to comply
with ASC 805
•  Loan portfolio
•  Depositor customer relationships (core deposit intangible asset)
•  Other customer relationships
-  Insurance
-  Trust/asset management
•  Certain liabilities
-  Time deposits
-  FHLB advances
-  Holding company funding (sub debt, trust preferred securities)

#AICPAfvs
Discount Rate
! Loan portfolio valuations
•  Key estimates:
-  Prepayment speeds
-  Credit losses
-  Probability of default / loss given default methodology
-  Discount rates
-  Rates on newly originated loans
-  Rates on traded debt instruments
-  Funds transfer pricing analyses

#AICPAfvs
Discount Rate
! Core deposit valuations
•  Generally valued using a “replacement cost” approach
•  Key estimates:
-  Cash flow stream
-  Fully loaded cost of deposits (interest cost + servicing
costs – noninterest income)
-  Cost of alternative funding
-  Attrition rates
-  Study of account closure activity
-  Discount rate

#AICPAfvs
Information Sources

#AICPAfvs
From Bank
! Board packets
! Asset quality information:
•  Past-due/classified loan reports
•  Loan loss reserve calculation and supporting documentation
•  Write-ups of significant classified loans
•  Schedule of other real estate owned
•  Loan participation reports
•  Loans to large borrowers report
•  Loan concentration report (such as for industry concentrations)
•  Commercial real estate concentration analyses
! Securities portfolio inventories
! Asset/liability management reports
! Capital plan

#AICPAfvs
Publicly Available
! Federal Financial Institutions Examination Council (www.ffiec.gov)
•  Regulatory filings for bank holding companies (FR Y-9s)
•  Regulatory filings for banks (Call Reports) and thrifts (Thrift Financial Reports)
•  Uniform Bank Performance Reports – peer group data
! FDIC (www.fdic.gov)
•  Regulatory filings for banks (Call Reports) and thrifts (Thrift Financial Reports)
•  Reviews of industry performance
•  Summary of Deposits – tracks deposit market share for banks
•  Regulatory orders
! SNL Financial (Charlottesville, VA) (www.snl.com)
•  Track and sell data on bank M&A transactions
! American Bankers Association (www.aba.com)
! American Banker newspaper (www.americanbanker.com)
•  In particular, see Banker’s Glossary (http://www.americanbanker.com/glossary/a.html)
! Mercer Capital (www.mercercapital.com)
•  Monthly BankWatch publication, summarizing regional trends in bank stock pricing and
bank M&A activity
•  The Bank Director’s Valuation Handbook provides an overview of valuation issues
frequently occurring among financial institutions

#AICPAfvs
Questions?

59

#AICPAfvs
Andrew K. Gibbs, CFA, CPA/ABV
gibbsa@mercercapital.com | 901.685.2120

Mercer Capital
5100  Poplar  Avenue,  Suite  2600  |  Memphis,  TN  38137  
www.mercercapital.com  |  901.685.2120  (p)  |  901.685.2199  (f)  

#AICPAfvs