Valuation Considerations for Financial Institutions
This blog was authored by my colleague Gwendolyn Duda, a signing director in our valuations, forensics, litigation, and investigations (VFLI) group.
In a time of competitive economic conditions, valuations of financial institutions are increasingly instrumental for supporting business strategy decisions. Financial institutions continue to face near-term headwinds with rising inflation, rising interest rates leading to increasing deposit costs, and decreasing market values of security portfolios. Additionally, the ever-evolving regulatory changes continue to necessitate time and resources which are costly in nature. However, long-term growth is achievable through maintaining and growing relationships, continued investment in technology and innovation, and placing an emphasis on customer service.
Questions to Ask
Many events can trigger the need for business valuation. Valuation is forward looking, so what should financial institutions consider?
- The potential acquisition, merger, or sale of a financial institution
- Understanding what happens in a buyout
- The impact of share based compensation
- Testing goodwill for impairment
Valuation Drivers
Financial Metrics – The most commonly used financial metric in financial institution valuation is tangible book value (“TB”). Tangible book value is often assessed due to its commonality and simplicity. However, earnings potential is crucial in valuation as it is forward looking and the source of returns to stakeholders. Financial institution investors consider net income and earnings per share, as bank revenue is derived from interest rate spreads. Investors may also consider pre-tax operating income excluding provisions given current distressed credit quality.
Risk Management– Financial institution revenue continues to be affected with current macroeconomic uncertainty. With the potential of financial institution borrowers struggling to repay loans, financial institutions continue to make significant provisions for credit losses. As new risks emerge, financial institutions that focus on helping borrowers solve their problems, rather than on collections, will outperform their peers.
In addition, financial institutions are susceptible targets for fraud and cyberattacks. In the modern age of technology and digital advancements, prevention and detection has become more difficult. Other risks that present challenges to banks if not addressed, include innovation and quality; retention of talent to meet customer expectations and grow relationships; and the ability to leverage and utilize data more effectively.
Growth – As competition for deposits increases and interest rates stabilize, financial institutions will focus on maximizing net interest margins. In addition, as banks leverage more digital processes to drive cost reduction strategies, there are growth opportunities in reaching customers more efficiently – while keeping at the forefront risk management strategies in the development of these emerging areas.
As part of their growth strategies, financial institutions should also consider personnel management by implementing consistent cost administration through cultural changes; more disciplined performance incentives; and ensuring short term capacity reductions will not jeopardize the financial institution’s ability to service new business at the onset of economic recovery.
Regulatory Environment – The industry continues to see increases across supervision, enforcement and investigations under both old and new regulations.
How can CLA Help?
CLA is innovative in our strategies and has capabilities to assist financial institutions. Please Contact Us for additional questions or for assistance on the following valuation items that could be impacting your institution:
- Loan portfolio valuation
- Core deposit intangible valuation
- Mark-to-market for time deposits
- Investment portfolio valuation
- Goodwill impairment
- Stock options, warrants, and derivatives valuations
- Tax strategies
Dean has more than 25 years of experience providing audit, internal audit, and consulting services to financial services companies. He has provided consulting services in the areas of business lending, product costing and profitability, and asset/liability management. Dean has worked with a number of financial services companies on strategic issues such as board governance and enterprise risk management, as well as the role of internal audit and risk management, regulatory issues, and many accounting related topics.
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