Retail Bank Valuation

Banks are valued differently because they utilize debt as a sort of raw material rather than for reinvestment. While it is almost laughable to try and arrive at a solid figure given the amount of uncertainty currently pervading the financial markets, you do have some alternatives for valuing your plain vanilla retail banks:

1. Comparable company analysis with only equity based multiples. Agg Value multiples, and indeed the notion of ebitda, are irrelevant for these purposes. Use Price/Book and Price/Earnings

2. Acquisition Comps w/ deal value as a multiple of either book or earnings. Also, you could use the core deposit intangibles associated with various deals. Essentially, taking the goodwill from an acquisition as a percentage of the target's core deposits gives a premium that a firm would pay for that source of financing. It gives a picture of how cheap deposit financing is relative to other forms of capital.

3. Intrinsic value. For reasons I've already discussed, however, you'd use a dividend discount model. First, you'd project out the firms financial statements. Then you'd assume how much regulatory capital (this is an important issue, make sure you're knowledgeable about the various definitions of regulatory capital ie all tier 1 vs tce) the firm will need to maintain, and from there determine how much of earnings can be paid out as dividends to equity, indeed cash flow to equity. Since banks don't require much in the way of reinvestment, this is a reasonable thought experiment. From here, you'd take the NPV using CAPM and some relevant multiple of the last year's projections to get the terminal value.

hope that helps

thanks, that's exactly what I was looking for. Why is ebitda irrelevant though?

Going for an interview in a FIG space and you don't understand why EBITDA is irrelevant?

Answer these questions:

1. What does EBIT/EBITDA stand for?
2. What does S&L stand for? And what do banks receive and pay on these asset and liability accounts?

The answer will be posted below.

Make sure you are familiar with the following terms: ROAA, ROAE, NPA/NPLs, Capital adequacy, NIM, NCOs, LLR,

Your focus should be tangible equity and (tier 1) capital ratios, familiarize yourself with book grind down, loan pools and exposure to various types of loans (resi, commercial RE, home equity, etc.)etc and the various geographical locations of these loans.

good luck

Can you guys recommend some resources (books/websites/training materials) for bank valuation? I will be joining FIG, and want some preparation.

It is obvious that our economy is not doing well and more and more people are now being affected by it. That’s why most of them would often run to payday loan for financial assistance. However, Tennessee is the next state on the get-rid-of-payday-loans-bandwagon. Payday loans legislation has been making its way through numerous state legislatures and currently Federal as well, and most popular among them is an outright ban on short term loans, cash advances, or whatever you want to call them. The Tennessee bill is for an interest rate cap, capping interest at 36%, tantamount to a death sentence, and despite numerous studies demonstrating that bans do no one any good at all, lobbyists still try and advocate for the bans anyway. Lenders in Tennessee would likely want some credit repair if the state bans lending payday loans.

As for EBITDA not being relevant because of "interest payments" for deposits (mentioned above), I understand that the interest on loans is similar to COGS for other companies and thus is subtracted as the first line item, to come to "Net Interest Income" and all the other measures of earnings are found from there.

Given this, why is EBITDA still not relevant?

THanks!

You seem pretty confused. Interest on loans is INCOME, not expense, and thus bears no resemblance to COGS. EBITDA is meaningless in a bank context because by its definition excludes interest income/expense, the main drivers of the bank income statement.

The only reason people use EBITDA to value businesses is that it's a proxy for free cash flow. The best comparable simple proxy for a bank's free cash flow is cash net income (adding back after-tax impact of D&A).

BUMP