In this episode of What’s New at CFI on FinPod, we’re excited to introduce our latest course, “Intro to Bank Valuations.” We’ve designed this course to simplify the world of bank valuation models by focusing on practical methodologies like the asset value approach, comparables, and the dividend discount model.

We dive into why mastering bank financial statements and Basel III regulations is a prerequisite of valuation performance, why traditional valuation metrics like enterprise value don’t apply to banks, global banking comps, insurance companies, and non-bank financial institutions.

Transcript

Asim (00:13)
Hello and welcome to the What’s New at CFI podcast. I’m Asim Khan, and I’m joined by my colleague Scott Powell, who is the chief content officer and co-founder of CFI. Scott, welcome to the podcast.

Scott (00:26)
Asim, It’s always a pleasure talking with you.

Asim (00:28)
Yeah, it’s lovely having you back and this time to talk about your newly published course on the Intro to Bank Valuations.

Scott (00:36)
Yes, I am super psyched about this course, partly because, well two reasons. One, learners have been asking for it. But number two is a lot of bank valuation models are overly complex and it’s really hard to learn. And one of our intents was to show you how you can actually get to that valuation without complicating it with hundreds and thousands of rows.

Asim (01:01)
Yeah, and there are a number of valuation methodologies that you go through. There’s the asset value approach, there’s comps, there’s you’ve resurrected the dividend discount model, which I guess, right? The residual value method. No, it’s really terrific. So, and this should be, I’ll tell viewers, best viewed

Scott (01:16)
Exactly.

Asim (01:32)
as an adjunct to your course on reading and analyzing bank financial statements.

Scott (01:37)
Yeah, Asim I wouldn’t even, I encourage people not even to start the bank valuation course unless you’ve done the reading banks financial statements or you already know how to read bank financial statements. But certainly, if you have not looked at them, please do the reading bank financial statements first and then go into this course.

Asim (01:56)
Right, and since part of the valuation has something to do with risk-weighted assets, we could even suggest that viewers check out the course on Basel III and risk management if they haven’t already done so.

Scott (02:08)
Yeah, which you hit the nail on the head because we’re talking banks. We need to tell you differently

for a number of reasons. One is the bank makes money off its balance sheet and it’s very hard to distinguish the funding of a bank from the operations of a bank. So you need to really understand that to do a bank valuation and you also need to understand those capital requirements under Basel III before you can value a bank because a bank, I know I’m telling you the obvious, but a bank can’t pay out as much as it always wants in dividend necessarily if that’s gonna erode its capital, its CET1.

Asim (02:21)
Mm-hmm.

Scott (02:42)
So it’s like that’s gonna be a limit on the amount of dividend a bank can pay out. And generally, as you also know, banks tend to be big dividend and stable dividend payers out there in terms of stocks. If you want dividend stocks, you often head to the banks.

Asim (03:01)
No, that’s absolutely true. And you said CET1 and that would be the Common Equity Tier One capital, right? One of the insights that stood out for me was that you won’t use enterprise value as we’ve done in our other valuation courses.

Scott (03:07)
Yeah, you got it.

Yeah, I think it comes as a surprise to most people, but the key reason is what I just mentioned is that you can’t separate the funding of a bank necessarily from the operations because deposits are funding the bank, but they’re also part of the operations of a bank. So we…

One of the biggest mistakes you can make is don’t go anywhere near enterprise value. Never use that term as it relates to a bank. We’d never talk about comps like EV EBITDA multiples. There’s no such thing as EBITDA for a bank, let alone the EV. And so we’re really, when you’re analyzing a bank, it’s all about equity multiples. And really, price to book would be the one I would pick on the most, or price to earnings.

Asim (04:01)
Right, and I’ve always, I guess the way I viewed it was to look at price to book as the most common metric and it should be somewhere between three to five times, you know, if a bank is properly valued. Are there other metrics that one looks at, like return on assets, would that be something that’s important in looking at a bank?

Scott (04:25)
Yeah, so that’s where you, if you go to our reading bank financial statements, it’s not just reading, I’ve truncated it, it’s also analyzing. And it’s, and one of the things you want to be mindful of is the ratios that you use to analyze the bank are going to be also different than the usual suspects. And so when we’re looking at evaluation, a couple of things, I think you’ve nailed it. The price to book is your North Star. And three times,

says you’re doing very well. And one time basically says you’re not creating any value for your shareholders other than the bare minimum. And we discussed that on the course. And that’s why we introduced that residual income method. Because the idea is that a bank’s only going to be worth the book value of its equity if it only delivers what shareholders need as a return on equity, the minimum.

Asim (05:09)
Mm-hmm.

Scott (05:20)
You know, and we can get a return on our cost of equity, I should say, and we can get that from, you know, like CAPM, the capital asset pricing model. And I love the price to book because basically, let’s say a bank shareholders need a minimum return of 8% and the bank only delivers 8%, then I don’t even have to do evaluation because I can tell you it’s going to be one times a price to book multiple.

Asim (05:49)
Right, right. So it comes in handy as a back of the envelope sort of thing. And then would this sort of evaluation methodology apply to, well, of course it applies to wholesale banks. I mean, that’s what we’re looking at in particular, you know, so Citi, JP Morgan, Wells Fargo, banks of this nature. If you’re looking outside the US, is it still applicable? Say you look at a BNP Paribas or something like that.

Scott (05:52)
Yeah, exactly.

Yeah, so it’s interesting because I’m working on a new course for insurance. And one of the things that allows you to use the same approach with banks within the US and outside the US is they’re generally regulated in a consistent way. And that’s what Basel 3 is about, creating standard rules whether you’re in France, the UK, the US, or wherever. But what I would also say is, and we mentioned this in the course, that…

Regulations are still different in different jurisdictions. And so if you’re thinking about comps, and I’m sitting in France, I’m not necessarily going to use a US bank as my comp. I’m going to try to find banks in France or banks in the EU that are subject to and also have a similar approach, similar, sorry, maybe I should say similar portfolio products and services.

Asim (07:06)
Hmm.

Scott (07:07)
Because you can get a wholesale bank that really is in every part of finance and banking, whether it’s capital markets, investment, banking, asset management, and so on and so on. Or you can get a regional bank that is only really doing loans and taking in deposits. But your first question was, can you use these valuation methods? Yes. But when it comes to using comps, just be very careful, even more careful, I would argue, than for other industries.

Asim (07:36)
Right, because I’m, for instance, like in Europe, credit cards aren’t the huge business that they are in the States because people are skittish about credit, right? So that changes the risk profile. Even though in the States, most of that credit card stuff is off balance sheet, still, you know, the bank’s holding a residual stake in it.

Scott (07:45)
Exactly.

Yeah. And I mentioned insurance because we don’t have global rules around insurance. So it’s even harder to compare. Insurance companies generally are regulated, but they’re regulated at the national or sometimes the supranational level, like the EU level. But there are no global rules. So that makes comparing insurance companies across borders even harder.

Asim (08:20)
Yeah, and I guess you’re developing a course on reading and analyzing insurance company financials as well. That’s a really niche thing, but I think it’s going to be super useful.

Scott (08:24)
Yeah.

Well, you know me, I’m really nerdy. So I’ve just finished the first draft of the course. I love the course, but I love nerding out on the nuances of an industry.

Asim (08:40)
I think it could have come in handy today because we got the announcement that Buffett is long about six and a half billion dollars of chub insurance. I’m sure there are people digging through the financials now going, what did he see? What did we miss? Right. Accumulated this huge position. So, yeah, I think it’s absolutely going to come in handy. And so I guess one last thing. So in the States, it’s very common that there are.

Scott (08:51)
Yes.

Yeah, yeah, totally.

Asim (09:09)
non-bank financial institutions that are doing consumer lending, and also on the private credit side, there’s a lot of corporate-type lending as well. Could some of these valuation methodologies be applied to these companies?

Scott (09:25)
The long and the short of it is, you’re not gonna like this answer, it really depends, right? And the reason I tell you it depends is there will be instances where these quasi -bank actors, if they have a balance sheet, I’ll give you a couple examples. If their balance sheet looks very similar to what we see as a typical bank, if their dividend pay,

Asim (09:30)
Okay.

Mm-hmm.

Scott (09:49)
And you would screen them and say, okay, this approach works. But I’ve also seen a lot of private lending from pension funds. And so where private lending is just one asset class they’re investing in. And so you wouldn’t take a pension fund’s financial statements and suddenly say, I’m going to value this like a bank. It really, yeah, it really depends how pure play, yeah.

Asim (10:03)
Right.

Right, okay. You absolutely wouldn’t do that. So I guess I was looking at a company the other day. It’s in two businesses. One is unsecured consumer loans, and it white labels a credit card product through some big servicer. That looks suspiciously like a bank. If you look at the financials, it’s got interest income, interest cost. They look very much like bank financials.

Scott (10:20)
Okay.

Yeah, and I would say that’s great one nuance, sorry, just because I’m nerding out again is that we also want to see if they’re subject to the same type of regulatory framework. And if we do see that, that’s then the final tick that says, okay, we can value this like a bank.

Asim (10:49)
Right, okay, great. So, I mean, so this has like broad applicability across corporate structures and geographies as well. So that’s really great. Okay, Scott, thank you so much for your time and we’ll see you again, I’m sure. Okay.

Scott (10:53)
I was.

Yeah, exactly.

Always a pleasure.