Hi I was wondering if anyone has a bank / insurance DCF that they can share with me. I am mainly try to get a bettter grasp on how you build to FCF for a regulated FIG entity. I understand that you typically use a levered FCF for these given that the debt in these busineses as effecitvely an "input", but I am trying to understand what other adjustments you may make to FCF. Thanks in advance.
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Don't you use a DDM model, not a DCF? Bump-ing this for visibility.
DDM is one approach for sure - but I am very certain that you can use a DCF to value a bank or insurance company - as just like any other business that value of the business would be determined by the cash it produces.
No you fucking can't
So my thinking it would look something like this:
FCF = Net income + depreciation - capex - additional capital required for regulatory reasons
How so? First, the bank's own business model is to pay interest on the deposits it has while lending it out. Second is that it has capital regulations in-place so it can't pay out all of its cash flows as dividends.
Bump great question & also following
The traditional method for doing a DCF does not work for balance sheet FIG companies due to the operational nature of debt and certain regulatory hurdles. The key here is understanding that for FIG balance sheet companies, we really only care about ROE or ROTCE, so it is going to be a valuation based on net income.
For banks, to do a basic DDM (DDA - Dividend Discount Analysis), you project out the certain target capital ratio (e.g. CET1 or Tier 1 Leverage Ratio) as well as your risk-weighted assets. Anything above the target capital ratio would be considered distributions as dividends or "cash flows" to the common equity holders and anything below would be considered a required capital injection into the business.
Initially, you would typically have a larger capital ratio than your target, so all the excess would be distributed as a dividend at dollar-for-dollar and you would have whatever your target remaining capital for the roll-forward (e.g., let's say you have $100MM target CET1 and currently have $150MM CET1 capital, so to get 10% CET1 ratio you would have to distribute $50MM as a dividend out, so your remaining capital or cash flows that could go to the common shareholder would the be the difference and $(100)MM "cash flow" in your current date).
For the horizon period, let us say that the target CET1 next year was $100MM and that you generated $10MM in adjusted net income (excluding incremental dividend payout), then you would have a dividend distribution of beginning CET1 + adjusted net income - Target CET1 ratio. You essentially repeat this simple formula until your terminal year which you also include the terminal value based on a forward P/E. Afterwards, just discount all the dividends to present and you will arrive at your DDM value per share.
To do a basic DDM is not that complex, but all the bells and whistles will be in the correct roll-forward of your risk-weighted assets and your adjusted net income.
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