Hello. Any body came across a decent book/website regarding bank valuations and how to build financial models for commercial banks? I have been a telecom analyst for the past five years, but now i am asked to value a bank, which would require major modifications to the normal financial model used for the valuation of telecoms or industrial companies. Many thanks
This might help you a little bit or at least give you a basic idea. http://pages.stern.nyu.edu/~adamodar/ Click Spreadsheets on the left Scroll down to the green/yellow colored section and there’s a spreadsheet for Financial Service Firms
night_screamer101 Wrote: ------------------------------------------------------- > Hello. Any body came across a decent book/website > regarding bank valuations and how to build > financial models for commercial banks? I have been > a telecom analyst for the past five years, but now > i am asked to value a bank, which would require > major modifications to the normal financial model > used for the valuation of telecoms or industrial > companies. > Many thanks I wouldn’t even think you could do “major modifications” to a operating company model to come up with a bank model. You’ll pretty much have to start from scratch. Just look at PEG ratios.
I don’t know squat but when I read bank valuations I see them focusing on book value and interest rate margins (NIMs?). Financials suck. Too many CFAs chasing them cuz it’s the only thing they think they understand.
This is FIG stuff, so you could tap your FIG group for help on this. Just discount the excess returns at the cumulative cost of equity and slap in the terminal value at the end also discounted at the cum. cost of equity before terminal growth . This would give you the equity value in the bank. Note you can’t add in debt like an operating company since all the banks capital is pretty much loaned out, so your valuation is pretty much based on equity value for commercial banks, investment banks and investment management firms. Also, look at Damodaran’s website for examples… Terminal value for excess returns is the same for any stable growth model. TV Excess Returns = [NetIncome - EquityCost}*{1+g}/[ReL - g] The numerator is just {ROE-ReL}*[BV Equity], the excess return for the final year before stable growth.
Thank you guys, really helpful. just one question though, what do u mean by the cumulative cost of equity that i should be using to discount the cash flows, and would it yield the same result if i discount the expected cash flows utilizing the cf/(1+discount rate)^n years. Many thanks
i think the main point is forecasting cash flows is pretty much a useless exercise for a bank. cash is their product, so cash is always flowing out the door. i personally wouldn’t use that discounting excess equity returns stuff if this is for equity research. in my opinion that is great for textbooks and necessary in banking but is too theoretical for investment research. people here have given you technical methodologies but no insight into how to actually model a bank, which is the important part. i would forecast the IS and balance sheet and apply a range of historical p/b ratios. I can provide some tips on building a bank model if you want, but if this is a pure valuation exercise as opposed to a fundamental research model I probably won’t be much help.
Actually, Morgan Stanley research (and a few other sell-side shops, but i can’t name them off the top of my head) uses residual income model to value large cap banks, so the methodology is used in practice. I am not a banking analyst, but if I were to build a model for a bank, this is what I would do: - Start with the Balance Sheet - Forecast the the growth of their loan and investment holdings (broken down by types of loan/securities) - Make assumptions on the rate of return/interest charged on these assets and multiply it with the average balance of the loan/investment, this gives you your interest income - Forecast out the growth of their deposit, multiply its average balance with an assumed interest cost, this gives you you interest expense - There you have your net interest income - See what fee based revenue they generate, and forecast them individually either by some observable drivers, or just slap on a historical growth rate - Look at the historical efficiency ratio to forecast out non-interest expense - Model out CapEx by # of branches added, or by other observable drivers, then you can start calculating depreciation - Subtract tax - This should give you your net income fgure, from which you can do what ever you want to arrive at a value (residual income, dividend discount, ratios etc.) - Sanity check your model by looking at capital ratios, to see if the bank can grow at the pace you assumed without raising new equity and stil complying with capital ratio rquirement (either indicated by management their preferred capital ratio, or the min. regulatory requirement) What I outlined above is probably a simplified way of building the model. Again, I can’t tell you whether this is how bank anaylsts build their model.
Like I said, just my opinion. People use all types of stuff I don’t agree with. I’m in fixed income and therefore don’t spend much time on valuation so maybe I was too quick to dismiss it, but generally I’m a fan of simplicity where appropriate.
Big Nodge - care to share your insights / tips from your fundamental research perspective?
All FDIC insured banks have to file financial statements with the government. I have used what’s called UPBR (Uniform Bank Performance Reports) for valuing community banks before. They provide financial statements and a wealth of other information including ratios for the subject bank and its FDIC defined peer group. Go to FDIC.gov, click on the analysts link, then click on the uniform bank performance link. For the actual valuation, we typically just find public comps based on asset size, ROAA, ROAE, internal growth rate, geographic location, asset mix/deposit mix, etc. Then, apply a market mulitple (p/e or p/b ratio) to the subject bank maybe applying an adjustment to the multiple if the subject bank has a significanly different asset/equity ratio than the peer group. I have never done a DCF model for a bank. From my experience, a key determinate in bank earning power is the asset mix vs. liability mix. For example, are a high percentage of a bank’s deposits tied up in higher yielding jumbo CDs versus regular CDs or savings accounts (lower costing forms of deposits). Also, what is the composition of the balance sheet? Does the bank have a higher or lower percentage of its assets in higher (lower) yielding assets such as commericial loans (treasury securities, US agencies) than other comparable banks.