5 Fantastic Ways to Bank Valuation: Commit Them to Memory

We all know how it goes…

If you really want to buy something, you’re going to find a way to buy it.

The same holds true for selling.

If you really want to sell something, you’re going to find a way to sell it.

Valuation slows the process down.

It gives your rational side time to mount an argument.

That’s why valuation is important.

The valuation process breaks down is when the person doing the valuation incorrectly concludes…

“It’s not about the numbers…”

“It’s not about the models…”

“It’s not about the metrics…”

“I know what the bank is worth.”

The biggest problem is that most people sit down to value a company or business and they already have a preconceived value of what they are expecting to see.

The great irony is the more you know about a bank, the stronger those preconceptions are, and when those get set, your valuation follows.

In general, a composite of several valuation approaches will likely yield the most valid basis in which to form your conclusions.

That bears repeating…

In general, a composite of several valuation approaches will likely yield the most valid basis in which to form your conclusions.

Here are 5 bank valuation approaches you should strongly consider committing to memory:

You are likely very familiar with the first approach, which I call the “drive-by approach,” not much in terms of in-depth analysis – just multiples, and in particular, price to tangible book value.

The second approach is the next-door neighbor to multiples because it uses the price-to-book value multiple in a not so scientific way.

“We’re a better bank than that, so our multiple must be higher.”

Otherwise known as the “competitive approach.”

“Our people are better.”

“We beat them all the time in head-to-head competition.”

“They don’t know what they’re doing.”

“We are worth more than them.”

The third approach is starting to gather actual data, so it is more scientific than the first two approaches – recent comparable transactions – the “relative value approach.”

You look at similar banks that have been priced in the market right now.

Try looking at 10 recent transactions of comparable sized banks in comparable sized markets with similar performance ratios, very much like a peer group analysis.

As those who loan on real estate are aware, appraisals use the comparable sales approach.

You must really study the differences in the properties being used for comparison to get a valid understanding of the value you are measuring.

The fourth approach is the “intrinsic value approach.” Now we’re getting more specific relative to the bank being valued. We’re valuing the bank on its fundamentals, its cash flows, its growth, and its risk.

At its core, the value should be a function of the bank’s future cash flows.

This ties back to the buyer’s desire to see what they can do and what they can become with your bank in the fold.

This is critical for you to understand because you need to help them paint the picture of the future – and only you can relay what your bank is capable of doing if it had the capital of your buyer. (See newsletter 014 – Community Bank CEOs: Want a successful bank sale – Free your limits).

The buyer is looking at it from the perspective of, “What price should I pay now in relation to the return I am going to get in the future?”

In a discounted cash flow valuation, the value of the asset is the net present value of the expected future cash flows of the asset. Nothing more, nothing less.

Discounted cash flow analysis is the most common tool used for estimating intrinsic value, but it’s not the only one.

The key to intrinsic value is that it is all about the future of the bank.

The fifth approach is the buyer’s “ability to pay” (“ATP”).

The buyer’s ability and willingness to pay is really a function of two factors:

• Strategic interest – which is totally subjective.
• Financial interest – which is more objective.

An example of a strategic interest would be you’re a collector, and there is a specific item missing from your collection.

You may be willing to pay above and beyond the market value for that one item because when it completes your collection, your collection increases by greater value than your above market payment for the one piece.

An example of a financial interest is a little easier to consider as it is more objective than subjective.

Common acquisition criteria are:

• Earnings per share. Specifically, what impact will this acquisition have on my earnings per share going forward?
• What kind of internal rate of return will I get?
• Buyers will look at what level of tangible book value per share dilution will be realized and how long it takes to earn that back.
• Capital levels. Where does this leave us in terms of capital? Do I need incremental borrowings or common or preferred equity to finance the acquisition? Are there other associated costs that need to be factored in?

There is generally a range a buyer has for each of these criteria.

So, what do you do with all of this?

You look at a grid of the valuation ranges produced by each of the five approaches.

This side-by-side comparison will provide an overall range of values a buyer could reasonably pay.

This analysis provides a more informed understanding of the value of your bank beyond…

“I know what the bank is worth.”

Action plan:

• Try putting this information together for your bank. See where you run into difficulty with your analysis.
• Do you need access to information you currently don’t have available on your own?
• What is the information you need? It’s often easier to find once you identify it.
• Are there subscription services that provide the information?
• Are there investment bankers you feel comfortable enough asking for assistance without any strings attached?

There are zero hacks or tricks in this newsletter. Just proven tactics that help you choose the right path for your bank.

Your path will:

• Inform your strategic plan.
• Guide your annual business plan and budget.
• Clarify priorities.
• Define your message so it can be communicated with confidence.

This is how savvy bankers navigate.

They build smart and valuable banks and choose the best time to sell – serving the needs of the shareholders and the board.

I hope you found this short lesson helpful.

What are your thoughts?

I’ll see you next week.