A bank is very different from a normal production company. It deals with financial products like loans and deposits, transactions and investments. Banks receive interest payments from their outstanding loans – the loan portfolio, and pays interest to the deposit portfolio. Thereby a bank makes money from the margin between the interest rate they charge and the interest rate they pay. Furthermore a bank makes money by performing transactions on behalf of customers, which results in fee and commission income, and by investing its own funds. Valuing Banks has always been difficult due to the problems with estimating cash flows as you normally do in a DCF-model. The problems occur because the distinction between operating income and financial expenses to creditors can’t be made due to the nature of the banking business. Furthermore there are issues like different accounting rules and regulation from the government to take into account. Therefore it is necessary to use a different valuation model when you want to estimate the value of a bank. First of all you have to realize that debt should be seen as a sort of raw material, not capital. The only sort of capital to focus on when dealing with banks is equity. Thus it is only the cash flow to equity that is interesting in the valuation context. You should start by forecasting the income statement. The forecasting period should be at least ten years, as banks are highly sensitive to the state of the economy, and consequently you want to forecast through both recession and boom periods to reduce the risk of over or under valuing the company significantly. Impairment losses on loans and value adjustments are especially volatile. Impairment losses should be low when the economy is healthy and high in a recession. When the income statement is forecasted you compute the equity cash flow. This is done by forecasting the weighted assets and setting a target for the solvency, from which you can compute the necessary level of capital within the bank. The equity cash flow is the part of yearly income that can be used for dividends or stock buy-backs, when the necessary level of income is plowed back to equity. The equity cash flow is discounted back to present day with the cost of equity and this yields the total estimated value of equity from your valuation. When estimating the cost of equity, you have to take regulatory risk and rating into account. This can be done by raising the beta which is used in the capital asset pricing model.
|Educations||MSc in Finance and Accounting, (Graduate Programme) Final Thesis|
|Number of pages||83|