Bank Valuation

BANK VALUATION1

this version: February 13, 2001

1. Introduction

In this document we discuss: 1. What’s the bank’s cash flow? 2. FCF valuation approaches to bank balance sheets and income statements 3. Bank cost of capital, WACC 4. Two examples of a valuation • • FCF valuation Dividend projection as a residual

2. Analyzing the bank’s balance sheet

Banks borrow money (whether in the form of deposits or of loans from other financial institutions or markets) and then lend it out. It follows that when we are valuing or analyzing a bank, we should distinguish between the bank’s borrowing for the purpose of making loans and the bank’s permanent debt. (This is not to say that this distinction can always be made in practice.) The valuation process One way of viewing valuation is through the use of the accounting paradigm, but using market values. We rewrite the balance sheet by moving the current liabilities from the liabilities/equity side to the asset side of the balance sheet:

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This is a very preliminary draft of something which may eventually become part of a second edition of Benninga/Sarig’s Corporate Finance: A Valuation Approach. At this stage only Simon Benninga bears responsibility for the mistakes! I want to thank a number of people for helping me make my thoughts clearer: Dave Martin, Oded Sarig, students in my recent New York Institute of Finance course in Singapore. Special thanks go to Hernán Burde of Pistrelli, Diaz-Arthur Andersen (Buenos Aires). If you have comments/suggestions/case materials, please write me at benninga@wharton.upenn.edu.

Benninga/Sarig, Valuing financial institutions

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USING THE BALANCE SHEET AS AN ENTERPRISE VALUATION MODEL

ORIGINAL BALANCE SHEET

Assets Cash and marketable securities Operating current assets Net fixed assets Goodwill Total assets Liabilities Operating current liabilities Debt Equity Total liabilities and equity

THE ENTERPRISE VALUATION "BALANCE SHEET"

Assets Cash and marketable...