Valuing Banks (eBook)

Federico Beltrame is Lecturer in Banking and Finance in the Department of Economics and Statistics, University of Udine, Italy. He holds a PhD in Business Science from the same University. His main research interests are related to SMEs’ cost of capital, banks’ capital structure and Mutual Guarantee Credit Institutions.  Daniele Previtali is post-doc fellow and lecturer at Luiss Guido Carli University, Rome, Italy. He holds a Ph.D. in Banking and Finance from University of Rome, Tor Vergata, Italy. In 2012, he was a visiting PhD candidate at Stern School of Business, New York, USA. His main research interests concern banks valuation, banks’ capital structure and innovation. 

Dedication 6
Foreword 8
Acknowledgements 12
Contents 14
About the Authors 18
List of Figures 20
List of Tables 22
1: Introduction 26
References 30
2: Valuation in Banking: Issues and Models 31
2.1 Introduction 31
2.1.1 A Different Role for Equity: The Regulatory Constraints 32
2.1.2 The Role of Debt 36
2.1.3 Loan Loss Provisioning and Charge-Offs 38
2.1.4 Cash Flow Estimation 40
2.2 Valuation Methods of Banks: A Critical Review 43
2.2.1 Discounted Cash Flow Models 43
2.2.2 Excess Returns Valuation 47
2.2.3 Asset and Mixed-Based Valuation 51
2.2.4 Relative Market Valuation 55
2.2.5 Contingent Claim Valuation 61
2.3 Conclusion 61
References 62
3: Value, Capital Structure and Cost of Capital: A Theoretical Framework 65
3.1 Introduction 65
3.2 Limitations of the Equity-Side Approach 66
3.3 An Asset-Side Approach to Bank Valuation: An Introduction 68
3.4 Bank Cost of Capital and the Modigliani–­Miller Propositions: A Review 70
3.5 Bank Valuation: A Scheme with Separate Quantification of Mark-Down 79
3.5.1 Valuation Scheme without Taxation and Growth 79
3.5.2 Valuation Scheme with Tax Benefits 85
3.5.3 Valuation Scheme with Taxation and Growth 87
3.5.4 The AMM: An Overview 91
3.6 The Restatement of Modigliani and Miller’s Theories for the Banking Industry 94
3.6.1 Absence of Taxes 94
3.6.2 Presence of Taxes 96
3.7 Consistency of the AMM with Excess Returns Models 97
3.8 Conclusion 102
References 103
4: Measuring the Cash Flows of Banks: The FCFA Asset-Side Approach 106
4.1 Introduction 106
4.2 The Balance Sheet Reclassification 107
4.3 The Income Statement Reclassification 114
4.4 From Incomes to Cash Flows 118
4.5 FCFA and FCFE: The Case of Intesa San Paolo Bank 122
4.6 Conclusion 130
References 132
5: The Banks Cost of Capital: Theories and Empirical Evidence 133
5.1 Introduction 133
5.2 Pricing Systematic Risk 135
5.2.1 Pricing Systematic Risk in the Banking Industry 136
5.2.2 Determinants of Banks’ Equity Beta 137
5.2.3 Separating Business Risk from Financial Risk: The Effect of Bank Leverage 139
5.3 Pricing Total Risk 144
5.3.1 Pricing Total Risk through Implied Cost of Capital Metrics 146
5.3.2 Pricing Total Risk through Standard Deviation 150
The Assets Value Splits into “Certain” Value of Assets and Uncertain Value (CaR) 152
The Totally Levered Approach 153
The Unlevered Approach 158
5.4 Valuing Unlisted Banks through a Cost of Capital Comparable Approach: A Practical Example 163
5.4.1 The Financial Data of the “Small Bank” 164
5.4.2 Cost of Asset Estimation through the Beta of Comparable Banks 164
5.4.3 Cost of Asset Estimation through Total Beta Bank Comparable 165
5.4.4 Cost of Asset Estimation through CaRM: An Account Approach 167
5.5 Conclusion 171
References 172
6: Banks’ Asset-Side Multiples: Profitability, Growth, Leverage and Deposits Effect 176
6.1 Introduction 176
6.2 Literature Review: The Similarities Between the Target Firm and Its Comparables 179
6.3 Banks’ Market Multiples: Feasible Adjustments 181
6.3.1 Profitability and Growth Adjustments on Equity-Side Multiples 181
6.3.2 Asset-Side Adjustments: Additional Bank Market Multiples 184
6.4 Leverage and Deposits Effect on Bank Multiples 188
6.4.1 Unlevered Multiple in the Absence of Growth 188
6.4.2 Unlevered Multiples in the Presence of Growth 190
6.4.3 Calculating the Unlevered Multiple: A Practical Example 190
6.5 Conclusion 193
References 194
7: A Comparison between Valuation Metrics in a Real Case 196
7.1 Introduction 196
7.2 ABC Bank: Financial Statements and Business Plan 197
7.3 Measuring the Cost of Capital of ABC Bank 206
7.3.1 The CaRM 206
7.3.2 The CAPM 210
7.3.3 The CAPM with Total Beta 211
7.4 Valuing ABC Bank: The Application of the AMM 211
7.4.1 Balance Sheet Reclassification and Income Statement Adjustments 212
7.4.2 FCFA, Mark-Down and Tax Benefits 212
7.4.3 The ABC Bank Value using the AMM 219
7.5 Valuing ABC Bank: The Application of the DDM 224
7.6 Valuing ABC Bank: The Application of the FCFE Model 229
7.7 Valuing ABC Bank: The Application of Market Multiples 232
7.7.1 Equity-Side Approach: PBV, PTBV, PE 233
7.7.2 Asset-Side Approach: EV/OP and P/BVun (EV/A) 235
7.8 Conclusion: Comparing Valuation Methods 241
Reference 246
References 247
Index 256