Bank Board Letter — September 2014
Bob Wray

Whether you are buying, selling, raising capital, doing estate planning or just curious, you often want to know the value of your bank. Historically, privately held bank values were fairly easy to determine; they were almost always a multiple of book value Ð 1.5 times book; 2 times book, etc. Today, as with most things in the banking industry, bank values have become more complicated to determine.

Chances are, you have seen charts reporting the market value of banks. These charts are based upon a pool of sales transactions in a particular state, region or nationally. Often these reports are organized based on asset size. We all look at these charts and there is nothing wrong with them as long as you understand that in today’s market the information is normally not an accurate reflection of the value of your bank.

While the market statistics charts are interesting reading, pricing is not reported in many transactions and are excluded from the pool used to compile the chart. In others the pricing is simply not accurate. However, the biggest reason that these charts are not an accurate reflection of value for your bank is that your bank is not average!

The most important factor in valuation is a bank’s tangible capital. Assuming everything else is equal (which it never is), a bank with more tangible capital is worth more than a bank with less tangible capital. Today, goodwill or intangibles are often excluded or heavily discounted in determining value. Unrealized gains or losses in the bond portfolio may also impact value.

Additionally, capital above regulatory standards (excess capital) is typically valued at dollar for dollar. If a bank is worth more than its tangible capital, that premium is normally based upon regulatory capital, such as 8 percent of assets, plus the excess capital. Also, because asset quality can directly impact a bank’s tangible capital it has a major impact on the value. Fortunately, asset quality has become less of an issue in today’s market.

It is easy to understand the impact of capital and asset quality on valuation. It is a combination of other, sometimes more subtle, factors that are driving valuations. For simplicity, we will focus on the most significant items impacting valuations of community banks in today’s market.

Earnings are a major driver of valuation, and probably the most complex. At the end of the day, the value of any investment is based on the economic return on that investment. It sounds simple Ð the higher the earnings, the higher the value. However, not all earnings are equal. This is where the subtleties are important.

Are the earnings sustainable? If a material portion of the earnings are the result of a sale of OREO or bonds at a profit, those earnings would not be considered sustainable and are normally excluded from the bank’s earnings for valuation purposes.

Are the earnings derived from a single source? For example, a bank that depends upon mortgage origination as a significant portion of its total revenue may have wide swings in its earnings year to year created by the mortgage market as a whole. Therefore, timing of the valuation can have a significant impact on valuation if this is not taken into consideration. This does not mean that a bank should not have a mortgage department or that earnings from mortgage origination are not real. It simply means that the bank’s earnings may need to be averaged over a longer time frame to get a true value of the level of sustainable earnings for the bank. This applies to any seasonal or cyclical revenue source if the bank’s earnings are largely dependent upon a limited source of revenue.

Another element of earnings in today’s market is interest rate risk. With the expectation of interest rates rising in the future, a good understanding of a bank’s deposit and other borrowing rates and maturities, along with the level of fixed rate or variable rate loans and their maturities, is essential to the valuation process. Cost of deposits, the type of deposits, large depositors and noncore or public funds can all impact valuation. Valuation cannot just look at current or historical earnings, but must consider future earnings as well.

Another significant driver of valuation is location. The analysis of locations is similar to that of earnings. Are the locations sustainable over a long period of time? As mentioned with earnings, the value of any investment is based on the economic return on that investment. While earnings are the principle component of an economic return, the length of time you will receive these earnings (the future earnings) is also a significant factor.

As operating costs continue to rise and populations continue to shift, the long-term viability of a bank’s locations becomes a greater factor in valuation. Is the bank located where there will be sufficient long-term loan demand? Banks located in sustainable, growing markets should be able to continue their core earnings indefinitely, which will typically result in a higher valuation than banks located in markets that are stagnant or decreasing in size that may not be able to continue to generate the same earnings over an extended period of time.

Similar to the importance of location is the asset size of the bank. Normally, a larger bank is more economically sustainable over the long term than a smaller bank. This does not mean that smaller banks are not viable, just that they tend to have a lower valuation than larger institutions. Historically, statistics have shown that the larger asset size banks generate the higher multiple of equity and multiple of earnings in a sale.

There are many more factors that impact valuation but, as with the ones mentioned above, it is the impact of these factors on the current and future capital and earnings that directly impact the value of a bank.

Put as simply as possible, a bank’s value is directly derived from its tangible capital and its earnings. However, as briefly outlined above, it is the earnings potential of an institution that can cause two very similar looking banks to have two very different valuations, and why market statistics charts are not a very good indicator of value for an individual bank.

Bob Wray is president/CEO of The Capital Corp., LLC in Overland Park, Kan. He can be contacted at