Bank valuation

Water Cooler Investing
#1

Quick survey - how would you value a bank? I know of someone who wants to value by getting the NPV of the bank’s net income. (Which is totally different from the methodology I know - Justified P/B or Gordon Growth).

Thanks!

#2

There’s good info in here:

http://people.stern.nyu.edu/adamodar/pdfiles/papers/finfirm09.pdf

#3

^ thanks for sharing that. Very useful reading.

#4

The someone you know has the right approach (or at least better than justified P/B and GG). How else are you going to do it (assuming that asset writedowns/windfalls get reflected in bank net income, and that net income is not hopelessly distorted by accounting tricks)?

But figuring out bank net income years into the future is difficult. Justified P/B and Gordon Growth are simply shortcuts to NPV of net income using some not-always-valid assumptions.

The Damodaran article is - as usual - great for getting at the extra details to consider, and which numbers are cleanest to use.

#5

Damodaran is the man!

#6

I don’t know the “correct” answer but a few tings to look at:

  • Most importantly, you’ve got to figure out what their loan portfolio is worth. Much of their earnings, or at least revenues, in the next few years is already decided. It is the interest being spat off of the loans
  • Look at what is happening with charge-offs and the Allowance. Allowance as a percent of loans is low right now, relatively speaking, across the industry (in US)
  • Have their been changes in underwriting standards that need to be considered?
  • What are their industry exposures? Oil and gas lenders have had to take significant writedown in recent years for example
  • If they are big mortgage originator, where are we in the housing/refi cycle? It has been hot in recent months. At my employer, I have been blown away by the solid mortgage numbers,and it is a similar case at two other banks that I follow (listen to their calls just to understand the industry better)
  • Fed rates. Higher = better, at least directionally from current levels as it will likely decompress margins
  • Expense ratios.

These are just things I would look at off the top of my head. I do a lot of bank accounting, so am less comfortable with bank valuation than technical bank accounting.