This book presents the main valuation approaches that can be used to value financial institutions. By sketching 1) the different business models of banks (both commercial and investment banks) and insurance companies (life, property and casualty and reinsurance); 2) the structure and peculiarities of financial institutions’ reporting and financial statements; and 3) the main features of regulatory capital frameworks for banking and insurance (ie Basel III, Solvency II), the book addresses why such elements make the valuation of financial institutions different from the valuation of non-financial companies.
The book then features the valuation models that can be used to determine the value of banks and insurance companies including the Discounted Cash Flow, Dividend Discount Model, and Residual Income Model (with the appropriate estimation techniques for the cost of capital and cash flow in financial industries). The main techniques to perform the relative valuation of financial institutions are then presented: along the traditional multiples (P/E, P/BV, P/TBV, P/NAV), the multiples based on industry-specific value drivers are discussed (for example, P/Pre Provision Profit, P/Deposits, P/Premiums, P/Number of branches). Further valuation tools such as the “Value Maps” or the “Warranted Equity Method” will be explained and discussed. The closing section of the book will briefly focus on the valuation of specific financial companies/vehicles such as closed-end funds, private equity funds, leasing companies, etc.
Table of Contents
Preface vii
Acknowledgments ix
1 Bank Business Models 1
1.1 Economics of banking 1
1.2 Commercial banks 3
1.3 Investment banks 7
2 Financial Statements Analysis for Banks 15
2.1 Balance sheet 15
2.2 The US GAAP for banks 44
2.3 Profit & loss statement 49
2.4 Major differences between IAS/IFRS and US GAAP 51
2.5 Example of IAS/IFRS application 54
3 The Regulatory Capital for Banks 61
3.1 Regulatory capital requirements 61
3.2 Basel II 68
3.3 The reform of Basel III 73
3.4 Managing the regulatory capital 78
4 Assessing and Preparing the Business Plan for a Bank 81
4.1 Status quo analysis 82
4.2 Internal consistency 85
4.3 External consistency 92
4.4 The forecasting model of a bank 96
5 Bank Valuation 105
5.1 Why bank valuation is different 105
5.2 Discounted returns model 108
5.3 Relative valuation 123
5.4 Asset/liability-based valuation 137
5.5 The sum of the parts framework 143
5.6 Bank valuation in M&A 144
5.7 The valuation of Wells Bank 148
6 Insurance Business Models and Financial Statements 159
6.1 The business model of insurance companies 159
6.2 Segmentation by products 160
6.3 Distribution channels 162
6.4 Insurance balance sheet under US GAAP 162
6.5 Insurance contracts under IAS/IFRS 167
6.6 Case study 172
7 Regulatory Capital for Insurance Companies 177
7.1 Insurance industry regulation in the US 177
7.2 Current US system 178
7.3 Solvency II – European-based regulation 181
7.4 Main differences between solvency II and US regulation 190
8 Assessing the Business Plan for an Insurance Company 193
8.1 Status quo analysis 193
8.2 Internal consistency 195
8.3 External consistency 200
8.4 The forecasting model 204
9 Insurance Companies Valuation 209
9.1 Appraisal value 209
9.2 Relative valuation 215
9.3 The case of “general insurance” 216
10 The Valuation of Other Financial Companies 227
10.1 The valuation of finance companies 227
10.2 The valuation of funds 229
References 233
Index 235
