Question

Present Valuation of Financial and Banking Institution ----

Post the results of the valuation that you prepared of a financial and banking institution.

What are the results of the valuation analysis? What is the range of estimated value for 1 standard deviation above and below your best estimate?

What special problems were encountered in the valuation?

Answer 1

Bank valuation:

Valuation models are generally based on discounted cash flow approach & assume some growth stages. This is considered to be typical for different cash flow growth rate or owner’s resources.

The valuation of financial institutions is not possible without considering interest income & expense. The calculation of FCFE can be done in the following two ways:

1. FCFF: net income – growth of capital +other income.
2. FCFF = resources from issue of shares – preference shares +dividends – capital increase/ decrease.

Since the yield valuation considers the future potential of banks, it leads to questioning the length of the period.

Banks in Slovakia perform mixed operations & planning the future for more than 5 years could cause problems.

Net income as a basis for dividend or resource for owners can establish two basic ways:

On net income of interest or spread model (model based on interest margins).

In banks there can be differences in the proportion of own & foreign sources of funding comparing to any other businesses. Given the nature of business, banks must accept higher gearing ratio. Since any business has higher risk than depositing money I the bank, then expected return is higher than interest rates in the bank.

The cost of capital can be re invariably higher than r in connection with tax shield. Required rate of return on equity can serve a number of ways:

• Gordon growth model.
• CAPM
• Average profitability
• The cost of foreign funds.

Another alternative model is the dividend FCFE model. At times it can happen that dividend can be higher than FCFE this can add problems to management of financial institutions & cause uncertainty in the valuation. But for valuation of banks, FCFE is considered to be preferred as it is recommended when financial leverage is stable & is relatively higher. By using FCFE, banks are avoiding WACC.

PROBLEMS IN BANK VALUATION:

The key problem is that it has a future effect on the owner, plans for future net earnings.

Future profits can be detected in two ways:

• Regression method: this is more suitable for banks than for other companies because regulatory framework for banking business ensures continuous development without much fluctuation.
• A financial plan based on balance sheet & profit & loss account:

The most reliable way to estimate the deemed dividend is derived from financial plan of the bank. Important income indicators of bank’s income are loans & other earning assets, income from fees for services rendered, which also be included in the calculation.