With the rise of uncertainty amongst regional banks following the demise of Silicon Valley Bank, it’s an important time to understand how investors may value an institution and when board members should have a clear picture of that value.
“You should always understand what you’re worth,” says Kirk Hovde, managing principal and head of investment banking at Hovde Group. “Most banks say they aren’t for sale, but my view is most banks should operate as if they could be viewed … for sale.”
It can be easy to determine a public company’s valuation since it’s accessible through a brokerage, online resource or a tool like Bloomberg Terminal. For private companies, it’s something that requires further analysis. That can make planning difficult when weighing certain initiatives.
With valuations nearing Great Recession lows among public banks in 2023, according to research from the investment firm Janney Montgomery Scott, recognizing why and what investors use to come up with the numbers can be critical to how an organization responds. For banks, it’s required in many situations, such as when investors want to sell shares or the board needs to approve certain compensation packages.
Tangible book value (TBV) has become one of the most critical benchmarks that investors consider. This metric takes all the tangible assets the bank owns, including loans and buildings. The calculation excludes intangible assets like goodwill and debts — those would be removed from the balance sheet or paid out first during a liquidation event. This gives investors a sense of the value of the assets that can be liquidated if the bank suddenly goes bankrupt. They compare this figure to the stock price to calculate the bank’s price-to-tangible book value, which can be measured and benchmarked over time.
During times of sector strength, investors often look more at earnings growth instead of TBV. If earnings keep growing, then the bank looks stronger. Higher earnings during times of uncertainty can also make a bank look strong when others are weak. With bond portfolios struggling in the high interest rate environment, however, some banks may have to sell securities if earnings slow, says Hovde. This locks in losses.
“[Investors] have started to switch back to TBV currently, as they think about what losses might be recognized,” says Hovde.
Investors may also approach valuation by running a scenario called a “burn down analysis.” Essentially, this shows how quickly the bank would run out of funds if it had to pay creditors and cover liabilities immediately. This is a tactic that investors embraced during the financial crisis of 2008, says Christopher Marinac, director of research at Janney Montgomery Scott, who adds that investors have begun to run this type of analysis again due to the fears in the sector.
Investors often don’t take into consideration that banks typically have two to three years to pay down their entire credit cycle; a burn down analysis assumes the bank must pay all creditors immediately. As a result, it isn’t always accurate and can work to deflate the value of the bank.
“No one wants to see companies go away,” says Marinac. “There’s empathy in the credit risk process. Investors don’t think of it that way.”
While it’s important to understand a bank’s valuation from the investors’ perspective, directors also should have a sense of the institution’s value to weigh certain initiatives that could have sweeping impact across the institution.
It’s particularly important for directors to get a sense of their bank’s valuation in case it faces a potential liquidation event that no one expected. “Directors should be focused on liquidity and capital position to understand what the health of the bank really is,” says Hovde. “No one predicted the failures we have seen.”
Beyond liquidation, “there are a myriad of reasons” for bank directors to understand the valuation of their institution, and they’re not all for planning purposes, says Scott Gabehart, chief valuation officer at BizEquity, a valuation software developer.
Directors should have a sense of their bank’s valuation to make the right call when opting into a long-term plan. One example of this is when a private bank looks to implement an employee stock ownership plan (ESOP). These types of plans can serve as a retention tool by providing employees with a piece of the business that they work for.
When a company offers an ESOP, its employees can receive or buy shares of the organization, even if it’s a privately held. How many shares are available and whether the incentive tool will work depends, in part, on the valuation of the business. If it rises, employees can participate in the bank’s success.
Then there’s the fact that many bank executives receive stock options or grants as part of their compensation package. The options “must be valued at the time of granting,” says Gabehart. The valuation will incorporate other variables beyond earnings and TBV, like interest rates, volatility and other metrics. The perceived value that the executives receive from the options will depend, in part, on the valuation.
Finally, directors need to understand the bank’s valuation if they’re going to properly consider an acquisition or merger. Now, “it may be the best time to undertake an acquisition for expansion in that the multiples or costs to buying a bank [are] lower, all things equal,” says Gabehart. Of course, as Gabehart also acknowledges, it’s more difficult to fund an acquisition now, due to higher interest rates and weakened valuations for the buyer. Bank M&A activity slowed in 2022, with 164 bank acquisitions announced, according to S&P Global Market Intelligence. Through April 30, 2023, just 28 transactions had been announced for the year — down by half compared to the same period the year before.
“Before deciding how to finance an acquisition, it is always first necessary to know what the company is worth,” says Gabehart. Then leaders can determine the best funding tactic.
Beyond planning, there’s also the need for directors, as shareholders, to understand the value of the bank simply to sell their own shares. Understanding this valuation will ensure that whenever any other director sells shares, they will receive the best possible price — which benefits the entire organization.
The higher the valuation, the higher the sale price.
That’s not just good for the director. It’s great for the other bank investors as well.