Bank Management, 5th edition.
Timothy W. Koch and S. Scott MacDonald
Copyright © 2003 by South-Western, a division of Thomson Learning
BANK MERGERS
AND ACQUISITIONS
Chapter 22
Mergers and acquisitions continue to be a
significant force in the restructuring of the
financial services industry.
 The number of banks has declined from 14,451
banks in 1982 to only 8,080 in 2001.
 Total number of branch offices, however, grew
from 34,791 to 64,087.
Number of U.S.
Banking Offices 80,000
70,000
60,000
All U.S. Banking Offices
(Main Offices plus Branches)
50,000
40,000
Branches
30,000
20,000
10,000
0
Main Offices
1960
1965
1970
1975
1980
1985
1990
1995
2000
2001*
Branches
10,556
15,872
21,839
30,205
38,738
43,293
50,406
56,512
64,079
63,989
Banks
13,126
13,544
13,511
14,384
14,434
14,417
12,347
9,942
8,315
8,178
Fewer banks control a greater fraction of
banking resources.
 The largest institutions continue to buy
smaller institutions:

The largest banks (greater than $10 billion in
assets) make up less than 1% of the total
number of banks but control over 70% of bank
assets.
Concentration of assets with the larges banks
1993
1995
1997
Total
11,330
10,242
9,451
1999
8,580
2001
8,080
1993
Total
3,514
1995
4,116
1997
4,642
1999
5,735
2001
6,569
Number of Banks, Year-End
< $100 M $100M - $1B $1B - $10B
8,215
2,741
322
72.51%
24.19%
2.84%
7,123
2,741
331
69.55%
26.76%
3.23%
6,147
2,900
331
65.04%
30.68%
3.50%
5,157
3,029
318
60.10%
35.30%
3.71%
4,486
3,194
320
55.52%
39.53%
3.96%
> $10B
52
0.46%
63
0.62%
73
0.77%
76
0.89%
80
0.99%
Total Assets ($billions), Year-End
< $100 M $100M - $1B $1B - $10B
345
669
1,005
9.81%
19.05%
28.59%
310
668
1,077
7.54%
16.22%
26.17%
277
711
995
5.97%
15.32%
21.45%
243
755
915
4.23%
13.16%
15.96%
222
819
915
3.37%
12.47%
13.93%
> $10B
1,495
42.55%
2,061
50.07%
2,658
57.27%
3,823
66.65%
4,613
70.22%
Many factors have lead to the merger
mania of the 1990’s in banking.
 The 1990’s was one of unprecedented
growth in the economy.
 Bank’s experienced record profits from 1990
through 2001.
 Bank stocks values soared and this
provided valuable currency for banks in
acquiring other banks.
 The elimination of interstate branching
restrictions in the mid 1990’s
 Repeal of Glass-Steagall in the late 1990’s
and the resulting expansion outside
traditional product lines and across
international borders
Changes in the number of banks through
mergers, failures and new charters:
1980 – 2001.
700
Number of Banks
600
Mergers
500
400
300
New Charters
200
100
Failures
0
1980
1983
1986
1989
1992
1995
1998
2001
The impact of the Riegle-Neal Interstate
Branching and Efficiency Act
 Interstate branching restrictions were removed in




the mid 1990’s and the Riegle-Neal Interstate
Branching and Efficiency Act became fully effective
by June 1997.
Prior the Riegle-Neal Act, each state determined the
degree to which banks could branch across state
lines.
Many states did not allow interstate branching.
Riegle-Neal allowed for nation-wide interstate
branching.
Savings institutions, on the other hand, have
historically been allowed to branch across state
lines.
The impact on the liberalization of
interstate branching restrictions.


The number of interstate branches of commercial
banks increased significantly as they opened branches
and the number of banks declines as they collapsed
independent banks into branches of the home office.
The number of interstate savings institutions branches,
with there more liberal interstate branching laws,
actually declined until finally increasing again in 2001.
Mergers and acquisitions
 Formally, a merger is a combination of two or
more separate enterprises, typically involving
the issuance of new securities.
 An acquisition occurs when one firm
purchases the stock of another firm.
 Prior to the early 1980s, geographic and
regulatory restrictions limited where and how
banks could compete, interstate branching
was prohibited.

Mergers and acquisitions were a natural way to
penetrate new markets, particularly in-states
with no branching.
Liberalization of branching restrictions
combined with a rapidly growing economy
provided banks the opportunity to
consolidate and grow dramatically in size.
 At the end of 1996, prior to the enactment of
Riegle-Neal:


the largest U.S. bank was Chase Manhattan
Corp. New York, rank 17th in the world by
assets ($333.8 billion).
the next largest U.S. banks were:


Citicorp, New York (ranked 26st in the world);
BankAmerica Corp., San Francisco and JP
Morgan & Co. Inc., New York
At the end of 1996, six of the ten largest banks
in the world were Japanese banks.
Rankings of world banking companies
prior to full enactment of
Riegle-Neal interstate banking and
branching efficiency act: 1996
Rank
1
2
3
4
5
6
7
8
9
10
17
26
Company Name
Bank of Tokyo-Mitsubishi Ltd., Tokyo, Japan
Deutsche Bank AG, Frankfurt, Germany
Credit Agricole Mutual, Paris, France (2)
Credit Suisse Group, Zurich, Switzerland (1)
Dai-Ichi Kangyo Bank Ltd., Tokyo, Japan
Fuji Bank Ltd., Tokyo, Japan
Sanwa Bank Ltd., Osaka, Japan
Sumitomo Bank Ltd., Osaka, Japan
Sakura Bank Ltd., Tokyo, Japan
HSBC Holdings, Plc., London, United Kingdom
Chase Manhattan Corp., New York, United States
Citicorp, New York, United States (b)
12/31/1996
$648,161.00
575,072.00
479,963.00
463,751.40
434,115.00
432,992.00
427,689.00
426,103.00
423,017.00
404,979.00
333,777.00
278,941.00
Billions of dollars
Source: The AmericanBanker: http://www.americanbanker.com.
By the end of 2000 the largest banking company
in the world was Citigroup at just under onetrillion dollars and three of the largest ten
banking companies in the world were U.S.
banks.
World Rankings of Financial Companies (by Assets) after Mergers, the full enactment of
Riegle-Neal Interstate Banking and Branching Efficiency Act and Gramm-Leach-Bliley Act
2000
Rank
1
2
3
4
5
6
7
8
9
10
Company Name
Citigroup Inc , New York
Deutsche Bank , Frankfurt, Germany
Bank Of Tokyo-Mitsubishi Ltd. , Tokyo
J.P. Morgan Chase & Co. , New York
UBS, Zurich
HSBCHoldings , London
BNP Paribas , Paris
Bank of America Corp. , Charlotte, N.C.
Credit Suisse Group , Zurich
Fuji Bank Ltd. , Tokyo
Total
Assets
2000
$902,210.00
872,626.68
720,808.94
715,348.00
673,705.58
673,475.21
651,431.86
642,191.00
612,098.13
557,111.70
Note: Assets are in billions of dollars.
Source: American Banker, http://www.americanbanker.com/
Total
Assets
1999
$716,937.00
829,155.67
638,926.83
406,105.00
615,324.33
600,680.41
702,370.25
632,574.00
451,062.77
467,410.23
%
Change
25.84%
5.24
12.82
76.15
9.49
12.12
-7.25
1.52
35.7
19.19
Acquisitions have also moved outside
traditional product lines and across
international borders.
 Some of the largest lines of business acquisition
from 1998 to 2001:
 Chase Manhattan Corp., New York acquired
Morgan Stanley Dean Witter & Co., New York in
1998,
 Bank of New York Co Inc acquired Charles
Schwab Corp, San Francisco in 2001,
 Washington Mutual Inc Seattle acquired
FleetBoston Financial Corp.’s mortgage banking
operation in 2001,
 Citigroup, Inc. New York acquired Associates
First Capital Corp. Irving, Texas in 2000, and
 Chase Manhattan Corp., New York acquired PNC
Bank Corp’s trust services in late 1998.
Top line-of-business acquisitions
announced in 1998–2001
Buyer Name
Seller Name
Announce
Date
Assets
purchased
Chase Manhattan Corp., New York
Bank of New York Co Inc
Washington Mutual Inc Seattle
Citigroup, Inc. New York
Chase Manhattan Corp., New York
FleetBoston Financial Corp Boston
Mellon Financial Corp Pittsburgh
Investors Financial Services
Wells Fargo & Co. San Francisco
Chase Manhattan Corp. New York
GMAC Mortgage Corp., Pa.
State Street Corp Boston
PNC Bank Corp., Pittsburgh
Chase Manhattan Corp. New York
JP Morgan Chase & Co New York
Bank of New York Co Inc
Bank of New York Co.
GMAC Mortgage Corp.
First Union Corp. Charlotte, N.C.
Morgan Stanley Dean Witter & Co., New York
Charles Schwab Corp San Francisco
FleetBoston Financial Corp Boston
Associates First Capital Corp. Irving, Tex.
PNC Bank Corp., Pittsburgh
Liberty Financial Cos Boston
Standish, Ayer & Wood Boston
BankBoston Corp.
First Union Corp. Charlotte, N.C.
BT Funds Management Sydney
Wells Fargo & Co., San Francisco
Nationwide Mutual Insurance Co Columbus, Ohio
Midland Loan Services, Mo.
First Tennessee National Corp. Memphis
Advanta Corp Spring House, Pa
FleetBoston Financial Corp Boston
LTCB Trust Co.
Mellon Financial Corp.
First Albany Companies Inc. Albany, N.Y.
7-May-98
18-Apr-01
2-Apr-01
6-Sep-00
4-Aug-98
4-Jun-01
26-Apr-01
20-Jul-98
28-Jun-00
14-Sep-00
2-Apr-98
17-Jul-01
28-Jan-98
19-Oct-00
8-Jan-01
6-Mar-01
22-Jul-99
01-Apr-99
9-May-00
400,000
348,000
143,900
87,701
55,000
51,000
41,000
41,000
35,700
33,380
28,100
25,000
25,000
20,000
15,800
15,700
15,600
14,000
11,400
Type Of Transaction
Trust Services
Trust Services
Mortgage Banking Oper.
Specialty Finance
Trust Services
Investment Advisory
Investment Advisory
Trust Services
Servicing Portfolio
Trust Services
Mortgage Banking Oper.
Investment Advisory
Mortgage Servicing
Trust Services
Mortgage Banking Oper.
Trust Services
Trust Services
Mortgage Servicing
Securities Brokerage
Today, with interstate banking made permissible
by the Riegle-Neal Interstate Branching and
Efficiency Act and the repeal of Glass-Steagall
by the Gramm-Leach-Bliley Act, the push is to
have a nationwide or even globalwide bank and
to provide a full range of financial products.
 NationsBank-BankAmerica merger produced the first large-
scale, coast-to-coast banking franchise (Norwest-Wells Fargo
deal produced the second– doing significant business in all 50
states.)
 Bank One and First Chicago merger produced one of the largest
credit card banks.
 NationsBank and BankAmerica both purchased securities firms
in 1997, expanding the services they could offer.
 The Citicorp and Travelers merger produced the first
combination of underwriting and banking, a financial institution
with a global reach, the worlds largest banking organization and
a complete line of commercial banking, investment banking,
and insurance products.
Why is size so important?
 Historically, managers of the largest banks in
a market had considerable influence and
received extraordinary attention.
 They were compensated well, based to some
degree on the size of the empire they
controlled rather than bank profitability.
 They served on community, state, and
national boards that set policy and lobbied
legislators.
The traditional benefits of economies
of scale and scope in business
 Size, product diversity, and brand
identification, which generate benefits from
cross-selling more products to more
customers.

Size can reduce the large fixed costs required
for brand identification, distribution of a large
variety of products and services, and the
massive technology expenditure requirement.
 Enhanced operating leverage
 results from spreading fixed overhead cost
across a larger operating and revenue base.
 Reduction in a company's earnings risk
 enhances the value of a franchise by creating a
more diversified product and earnings base.
Mergers and cost efficiencies
 Even though the rapid consolidation has
improved efficiency ratios in the U.S. banking
industry, these benefits have yet to be realized
by the largest banks as compared with other
smaller banks.
 The evidence, however, suggests that average
unit costs are flat across different size banks.
 Size essentially represents prestige and
financial power.
Summary performance measures by bank
size, 1992 and 2001
< $100M
2001
1992
$100M to
$300M
2001
1992
$300M to
$500M
2001
1992
$500M to $1B
2001
1992
4,486
221.6
187.7
1,912
11.19
49.53
8,292
346.0
306.5
3,487
6.83
78.69
2,350
396.8
331.2
4,364
3.40
63.28
2,141
350.9
308.3
3,611
5.93
81.83
509
195.0
158.7
2,351
1.77
71.91
397
151.9
130.3
1,445
8.06
75.82
335
227.6
178.5
2,607
2.09
71.04
252
177.4
148.6
1,611
7.54
80.56
320
915.4
625.0
11,518
3.12
69.06
329
1,034.2
787.9
10,322
11.25
79.33
80
4,612.8
2,910.5
51,559
1.25
62.50
51
1,445.3
1,017.1
11,510
7.84
86.27
8,080
6,569.2
4,391.6
74,310
7.54
56.73
11,462
3,505.7
2,698.7
31,987
6.85
79.27
8.07
0.91
10.90
4.23
7.83
3.61
91.39
69.59
1.11
3.74
0.30
11.10
1.04
9.38
4.74
8.55
3.81
91.16
66.85
1.05
3.90
0.35
11.62
1.16
9.83
4.35
7.93
3.58
91.26
63.70
1.42
3.71
0.34
12.60
1.06
8.48
4.71
8.41
3.71
91.21
64.98
1.28
3.92
0.45
13.41
1.28
9.45
4.37
7.87
3.50
90.88
62.14
1.94
3.98
0.35
12.26
0.98
8.06
4.72
8.32
3.60
90.84
63.82
1.27
3.87
0.57
12.38
1.20
9.63
4.39
7.90
3.52
91.17
62.07
2.04
4.07
0.46
12.33
0.93
7.75
4.83
8.32
3.49
89.69
64.36
1.49
4.13
0.69
13.77
1.31
9.76
4.31
7.76
3.45
89.49
55.75
2.62
4.02
0.66
13.74
1.02
7.68
4.71
8.19
3.47
88.41
62.53
2.47
4.59
0.91
13.43
1.13
8.77
3.71
7.06
3.35
83.03
56.83
3.19
4.07
0.74
13.33
0.81
6.62
3.94
8.62
4.68
85.87
65.96
2.64
4.42
0.85
13.10
1.16
9.09
3.90
7.29
3.40
85.23
57.72
2.85
4.03
0.67
12.98
0.93
7.51
4.41
8.43
4.02
88.08
64.68
2.17
4.33
0.76
0.34
128.1
1.41
71.11
0.57
114.2
1.79
57.22
0.38
142.3
1.39
75.93
0.64
104.4
1.80
61.35
0.40
161.0
1.40
78.91
0.75
105.9
1.85
67.21
0.48
161.1
1.55
82.95
0.96
102.0
2.12
69.51
1.03
167.7
1.79
88.72
1.38
108.7
2.77
76.10
1.06
123.5
1.97
89.68
1.57
73.3
3.16
80.87
0.94
131.0
1.85
87.06
1.27
87.6
2.68
73.28
10.63
15.87
16.96
9.37
16.33
17.51
9.40
13.52
14.66
8.43
13.98
15.19
8.93
12.50
13.69
7.94
12.32
13.61
8.98
12.15
13.38
7.57
11.48
12.91
8.74
11.83
13.77
7.38
10.41
12.37
7.23
8.86
12.16
6.17
7.39
10.75
7.79
9.90
12.72
7.21
9.84
12.30
Bank Size
Year
Number of institutions
Total assets (in billions)
Total deposits (in billions)
Net income (in millions)
% of unprofitable institutions
% of institutions with earn gains
Performance ratios (%)
Return on equity
Return on assets
Equity capital ratio
Net interest margin
Yield on earning assets
Cost of funding earn assets
Earning assets to total assets
Efficiency ratio
Noninterest inc to earn assets
Noninterest exp to earn assets
LN&LS loss provision to assets
Asset Quality (%)
Net charge-offs to LN&LS
Loss allow to Noncurr LN&LS
Loss allowance to LN&LS
Net LN&LS to deposits
Capital Ratios (%)
Core capital (leverage) ratio
Tier 1 risk-based capital ratio
Total risk-based capital ratio
$1B to $10B
2001
1992
Source: FDIC Statistics on Depository Institutions (SDI), www.fdic.gov (http://www3.fdic.gov/sdi/index.asp).
> $10B
2001
1992
All Comm Banks
2001
1992
Merger value is created in two ways:
 The combined bank might be able to generate
increased earnings (or cash flow) compared to
historical norms.
 Increasing market share.

Even if earnings rates remain unchanged after a
merger, a bank can position itself as a future
acquisition target by capturing a greater share
of its deposit market.
Source of potential gains
Economies of Scale, Cost Cutting
Increase Market Share
Enhanced Product lines
Entry into Attractive New Markets
Improved Managerial Capabilities, and
Increased Financial Leverage
6. Financial and Operating Leverage
1.
2.
3.
4.
5.
What makes a merger unattractive?
 In financial terms, mergers are problematic when the
buyer does not earn the expected return on investment
in a reasonable period of time.
 One broad standard of performance is that a merger
should not produce any dilution in earnings per share
(EPS) for the acquiring bank greater than 5 percent.
 EPS dilution is measured as:
Current EPS of acquiring bank - pro forma EPS of consolidat ed entity
Current EPS of acquiring bank
Where;
pro forma consolidated EPS is a forecast value for
the upcoming period.
EPS dilution constraints
 The 5% standard suggests that some dilution
is acceptable because:


most transactions are financed by an exchange of stock
EPS for both the target and acquirer are not the same
initially.
 Most bank acquisitions do have a negative
short-term effect on earnings, dilute the
acquirer’s EPS, largely because the acquiring
bank pays a premium for the target.

To be a successful merger, however, this decline in EPS
should be of negligible size and short-lived for a merger
to be attractive to the purchaser.
A second hurdle is whether the acquisition,
when treated as an investment, earns the
expected rate of return over time.
 EPS dilution analysis focuses on short-run
performance.
 Many firms perform a workout time analysis
that focuses on long-run results.

The analysis essentially computes the time
necessary for the acquirer to earn enough to pay
for the initial investment and meet the
cumulative target return objective.
 Obviously, the less that the acquirer pays and
the greater the earnings growth, the shorter the
time required to generate the target return.
Valuations procedures
 Any merger or acquisition should be treated
as an investment and evaluated accordingly
 Thus, theoretically correct procedure for
determining value is to discount expected
cash flows from the new entity at the
appropriate discount rate.

Because this approach involves estimating
many key components of the present value
model, market participants typically use a
variety of less rigorous techniques to obtain a
range of fair price estimates.
Levels or types of value
…there are actually several types or levels of value.
 Controlling interest value
…the value of the enterprise as a whole assuming
that the stock is freely traded in a public market
and includes a control premium.


Control premium
…reflects the risks and rewards of a majority or
controlling interest.
A controlling interest is assumed to have
control power over the minority interests.
 Minority interest value
…represents the value of a minority interest “as if
freely tradable” in a public market.

Minority interest discount
…represents the reduction in value from an
absence of control of the enterprise.
Controlling interest value and minority
interest value assume that the interest is
freely tradable in a public market.
 If the entity were closely held with no (or little)
active market for the shares or interest in the
company, then a nonmarketability discount would
be subtracted from the value.
 Nonmarketabiliy Discounts.
…represents the reduction in value from a marketable
interest level of value to compensate an investor for
illiquidity of the security, all else equal.
 The size of the discount varies base on:



relative liquidity (such as the size of the shareholder
base);
the dividend yield, expected growth in value and
holding period;
and firm specific issues such as imminent or pending
initial public offering (IPO) of stock to be freely
traded on a public market.
Valuation methods
…several methods of valuation exist but generally
fall into two broad categories
 Comparable analysis
…often referred to as “comps” uses a direct
comparison of the target bank with similar
banks engaged in the same or similar lines of
business.
 Discounted cash flow analysis
…often referred to as DCF, estimates value by
summing the present value of all future
economic benefits (cash earnings) that will
come to the investors in the future.
Comparable analysis uses several
value metrics
 Price to Book Value
 many bankers and market analysts discuss merger
prices in terms of book values.
 Price to Earnings per Share (EPS)
 many analysts prefer to focus on earnings rather
than balance sheet values when estimating a market
price to pay
 Price to Total Assets
 a bank uses stockholders and depositors funds to
invest in the assets of the bank, theoretically,
therefore, the assets of the bank create value.
 Price to Total Deposits
 inexpensive core deposits are often seen as a bank’s
greatest asset.
Price to book value
… the book value of a share of stock equals the
book value of a firm’s stockholders’ equity divided
by the number of shares outstanding
 The book value of stockholders’ equity
equals the dollar amount of assets minus
the dollar amount of liabilities.
 The premium to book value in a transaction
compares the per share price offered to
target bank stockholders with the book
value of the target’s stock:
MPt - BVt
Premium to Book Value 
BVt
where:
MPt = per share market price offered for target’s stock
BVt = per share book value of target’s stock
Example: Premium to book value
 If the target bank’s book value per share
is $12.2 and an acquirer offers $22.2 per
share, the premium to book value equals
81.97 percent.

($22.2 - $12.2) / $12.2 = 0.8197
Valuing a bank using price to book value
…calculate the average premium offered for
similar banks and extrapolate an equivalent price
for the target if the same premium is applied.
 Average premiums for minority interests are found
by using a comparable companies analysis in
which comparable companies are those in similar
lines of business with similar assets sizes and
profitability characteristics.
 Average premiums for controlling interest value are
calculated using data from successful acquisitions
of similar type using a comparable acquisitions
analysis.
 The transaction price per share Pbv is:
 MPt 
Pbv  
 BVt

 BVt  avg
Example (continued): Price to book value
 If the target bank’s book value per share is
$12.2 and an acquirer offers $22.2 per share,
the premium to book value equals 81.97
percent.
 ($22.2 - $12.2) / $12.2 = 0.8197
 If average premium on comparable
transactions is 100 percent, the average
purchase price to book value multiple will
equal 2.0x and the transactions price for the
target bank’s stock should equal $24.4:

(2.0 x $12.2) = 24.4
Merger terms are also described in terms
of exchange ratios
…the number of shares of the acquiring bank’s
stock that target bank stockholders receive for
each share in the target bank.
 Exchange Ratio:
Pbv
BVt (1  Premium)
e

MPa
MPa
where:
e = exchange ratio, and
MPa = per share market price of the acquirer’s stock
Example (continued): Exchange ratio
 If the target bank’s book value per share is $12.2
and an acquirer offers $22.2 per share, the premium
to book value equals 81.97 percent.
 ($22.2 - $12.2) / $12.2 = 0.8197
 If average premium on comparable transactions is
100 percent, the average purchase price to book
value multiple will equal 2.0x and the transactions
price for the target bank’s stock should equal $24.4:
 (2.0 x $12.2) = 24.4
 If the price of the acquires stock is $55, then the
exchange ratio is 0.4463:
$24.4 $12.2 (1  100%)
0.4463 

$55
$55
Normalized equity capital
…capital levels at the target bank are
“normalized” to a minimum level of capital and
then excess capital is purchased dollar for dollar
 One surprise to potential sellers of banks is
the impact of “excess” capital.
 The 1990’s produced record profits and
many banks found their capital to asset
levels at well over 10 percent.
 Since capital, in excess of what is
“required” to satisfy regulatory
requirements and insure success of the
bank, can be acquired by simply issuing
stock or injecting this capital into the bank,
potential acquirers will not pay more that
dollar for dollar for “excess” capital.
Although what is considered normal
capital varies, 8% is often considered
a general guideline.
 Multiplying the average price to book
premium by the “normalized” equity for the
target bank and then adding back “excess”
capital, determines value.
 The normalized book value of equity
(BVnorm) and excess equity is found by:


Normalized book value of equity (BVnorm)
= total assets of target bank x normal equity
Excess equity
= total equity – normalized equity
The transaction price per share of target
stock under a normalized book value per
share approach (Pnbv) is determined by:
 Transaction price with normalized book
value:
 MPt 
norm
Pnbv  

BV
 $ excess equity
t

 BVt  avg
Example: Normalized book value approach
 Assume the target bank has:
 3 million shares,
 $338 million in assets,
 $35.5 million in equity,
 normal equity is 8 percent, and
 the average price to book multiple is 2x.
 Normal equity is $27 million and excess
equity is $8.5 million.
 The price per share of the company
(assuming 1 million shares of stock) is:

Pnbv = $20.83 share
= [(2) x ($27 million / 3 million shares)]
+ ($8.5 million / 3 million shares)
Premium to book value procedure
has many weakness:
 The most obvious weakness is that book value
may not even closely resemble a bank’s true
economic value.
 Premiums paid on other bank acquisitions
have no relation to the rate of return that an
acquirer can potentially earn on the
investment, and completely ignore risk.
Premium to Adjusted Book Value
 Because reported book value may differ
substantially from true economic value, it is
appropriate to compute an adjusted book
value of equity for the target bank that
recognizes the measurement error.
 Adjusted book value can be obtained by
adding or subtracting from the stated book
value the following items:





Change in loan loss reserve,
Change in market value of investments,
Change in other asset appraisals,
Value of off-balance sheet activities,
Value of core deposits.
Price to earnings per share
…many analysts prefer to focus on earnings
rather than balance sheet values when estimating
a market price to pay for a target bank.
 Valuation involves computing the average
purchase price to EPS ratio for similar
banks and then multiplying this mean ratio
by the target bank’s earnings per share
(EPSt).


Average price to EPS ratios for minority
interests are found by using a comparable
companies analysis.
Value for controlling interest is calculated
using data from successful acquisitions of
similar type using a comparable acquisitions
analysis.
Valuing a bank using
Price to earnings per share
 Transaction price, Peps is:
 MPt 
Peps  
 EPS t

 EPS t  avg
 Premium to book value is:
MPt - EPS t
Premium to EPS 
EPS t
 Exchange ratio is:
EPS t  (1  Premium)
e

MPa
MPa
Peps
A. Pre-Acquisition: December 31, 2001
Net income ($millions)
Bank ABC
$
Number of shares outstanding
160.0
Bank XYZ
$
14.0
32
4
Earnings per share
$
5.00
$
3.50
Total assets ($billions)
$
22.2
$
1.5
B. Forecasts for 2002
Assume: i) Net income for both banks increases by 10 percent.
ii) Bank ABC offers a 2-for-1 stock exchange whereby Bank XYZ stockholders receive 2
shares in Bank ABC for every share of Bank XYZ .
EPS Dilution Constraints
Bank ABC
Net income ($millions)
176.0
$
Consolidated
15.4
191.40
32
8
40
Earnings per share
$5.500
$1.925
$4.785
EPS dilution
$5.500 - $4.785
 13.0%
$5.500
Number of shares outstanding (millions)
$
Bank XYZ
Summary
1. With no acquisition, Bank ABC's EPS would increase to $8.05 by 2006.
2. Earnings at Bank XYZ would have to increase to $64.4 million in 2006 to increase its EPS to the same
$8.05 by 2006. Thus, earnings would have to grow at a 35.7 percent annual rate for dilution to be
recovered within five years.
One period earnings measure as a base
has numerous weaknesses:
1. An appropriate earnings measure would
reflect the volatility of earnings, which gives
some indication of the riskiness of the bank’s
operations.
2. It is not clear what time interval is
appropriate.

The current year’s EPS may be dramatically
different from EPS over the past few years,
and different still from expected EPS.
 Analysts get around these problems by using
a weighted average of historical earnings per
share figures, and then using a forecast
average value of EPS over the near future.
Price to total assets
…A bank
uses stockholders and depositors funds
to invest in the assets of the bank. Theoretically,
therefore, the assets of the bank create value.
 Average price per share to total assets per
share for similar banks are calculated using
comparable analysis

These average ratios are multiplied by the
target banks total assets to determine value.
 Formally, if we define TA as total assets per
share, the transaction price per share of
target stock under this approach (Pta) is
determined by:
 MPt 
Pta  
  TA t
 TA t  avg
Valuing a bank using price to total assets
 Calculate the average total asset premium
offered for similar banks and extrapolate an
equivalent price for the target if the same
premium is applied.
 Average asset premiums for minority
interests are found by using a comparable
companies analysis
 Value for controlling interest is calculated
using data from successful acquisitions of
similar type using a comparable acquisitions
analysis.
Example: Price to total assets
 Using the data from the previous example:
 3 million shares,
 $338 million in assets,
 $35.5 million in equity, and
 assuming the median price to total asset
multiple is 19.3 percent,
 the price per share of the company
(assuming 1 million shares of stock) is:
Pta
= $21.7 share
= [(0.193) x ($338 / 3 million shares)]
The price to total assets approach
suffers from many weaknesses as well.
 Many of these weaknesses are similar to
those of the price to book value procedure
outlined above.
1.
Reported total assets may not represent true
economic value.

2.
The book value of assets may be artificially
small in that many banks have significant “off
balance sheet” activities which enhance
value
The prices paid on other bank acquisitions
of total assets have no relation to the rate of
return that an acquirer can potentially earn
on the investment and they completely
ignore risk.
Price to total deposits
…Inexpensive
core deposits are often seen as a
bank’s greatest asset
 The growth in core deposits is on the
decline today as investors continue to move
their money to mutual funds and direct
equity investments.
 As such, a bank could enhance its value as
a future acquisition target by capturing a
greater share of its deposit market.
 A larger market share of deposits can also
lead to an enhanced product line and open
new markets.
Valuing a bank using Price to total deposits
 Average price per share to total deposits per
share for similar banks is calculated using
comparable analysis and these average ratios
are multiplied by the target banks total
deposits to determine value.
 Formally, if we define TD as total deposits per
share, the transaction price per share of
target stock under this approach (Ptd) is
determined by:
 MPt 
Ptd  
 TDt

 TDt  avg
Example: Price to total deposits
 Using the data from the previous example:




3 million shares,
$338 million in assets,
$35.5 million in equity, and
assuming the median price to total deposits
ratio of 24.6 percent, the price per share of the
company (assuming 1 million shares of stock)
is:
Ptd = $22.9 share
= [(0.246) x ($279 / 3 million shares)]
The price to total deposits approach
suffers from many weaknesses as well.
 Many of these weaknesses are similar to
those of the price to book value procedure
outlined above.
1.
Reported total deposits may not represent
true core deposits.

2.
The bank may have obtained their deposits as
brokered deposits or by offering a premium
rate over the Internet.
Just because a bank acquires core deposits,
these deposits will only enhance the
acquiring banks profitability if they are
successful in reinvesting these funds at a
profitable spread and these deposits remain
with the bank.
Discounted cash flow (DCF)
 This approach views the purchase of a bank’s stock as
an investment and compares the present value of
expected cash flows discounted at some target rate of
return with the current equity value.
 If the discounted value exceeds the current equity
value, the net present value of the stock purchase is
positive and the investment meets the minimum
required return.
 The real value of this procedure is that it provides an
estimate of economic value.


The estimated value or premium to be paid for the target
bank’s stock is often lower as compared to other
approaches because only realized cash flows are
incorporated in the analysis.
Thus, sellers often ignore this analysis when they have
any market power.
Valuing future earnings
 When investors makes an investment, they are
looking for future income, thus, the value of
any investment is the present value of all
future economic benefits (cash earnings).
 The analysts must estimate the dollar amount
of earnings available to investors, the volatility
of the earnings, their longevity, and the
certainty of the earnings.
 The price (or value) bank investors' are willing
to pay is the present value of all future income
available to investors:
 Bank Value
= PV [Expected cash income available to
parent bank]
DCF valuation in practice
 In practice, the value to an investor is the present
value of expected future cash income plus the terminal
or salvage value the investor would receive at the end
of the investment’s life:
value = PV [expected cash income
available to parent over n years]
+ PV [terminal value (TV) in year n]
 Application of this method requires estimates of:




expected future cash earnings available to the parent
bank,
the number of years the income is expected,
the terminal value or salvage value of the bank in the
future, and
the required return or discount rate of investors.
Estimating future cash flows
 Any application of this method requires
estimates of:




expected future cash income available to the
parent bank
the number of years the income is expected
the terminal value or salvage value of the bank
in the future
the required return or discount rate of investors
 Expected future cash income available to
investors (FCF) can, under certain conditions,
be estimated by:
FCF = NI + depreciation
- required capital additions
Required capital additions
 Once a bank is purchased, the parent will
presumably try to minimize capital at the subsidiary
bank such that the parent can maximize their return
on investment (equity).
 Hence, required capital additions are a function of
existing equity (TEt-1), earnings (NI), total asset (TA)
growth, and the required capital to asset ratio:
required capital additions

TEt -1 

TA t  new equity
  required capital asset ratio TAt 

 Ignoring depreciation and new equity issues, future
cash income available to investors (FCF) can be
approximated by:

TEt -1 
FCFt  NIt - required capital asset ratio 
 TAt
TAt 

Estimating terminal value
 The life expectancy of the bank is usually
unknown or indefinite, so that the terminal
value of the investment is difficult to
determine.
 There are two approaches to this problem:


simply ignore income beyond a certain time
period
employ the mathematical solution to an infinite
stream of future income
Ignore income beyond a certain time period
 This method uses the two facts:
1. our estimates will not be perfectly accurate
and accuracy will diminish over time
2. the use of present value reduces the degree
of the error
 Example:
 the present value of $1 per year as a
perpetuity (infinite number of years)
discounted at 15 percent is $6.67 ($1 / 0.15)
 the present value of $1 for only 20 years
(ignoring all flows after 20 years) at a 15
percent discount rate is $6.26
This is a 6.2 percent error.
Solution to an infinite stream
of future income
 The second approach used to approximate the
terminal value (TV) is to employ the
mathematical solution to an infinite stream of
future income.
 Recall that the present value of a constant
infinite stream of income would be:
FCFt 1
TVt 
r
 The present value of a infinite stream which
increases at a constant rate (g), would be:
FCFt 1
TVt 
r-g
Break the problem into two parts:
1. The first in which explicit FCF estimates are
made,
2. The second in which a stabilized income is
projected to grow at a constant rate into the
indefinite future:
n
FCFt
TV
Bank Value  

t
n
(1

r)
(1

r)
t 1
 If we assume the target bank’s stabilized
income will grow at a constant rate, g, then :
FCFn 1
n
FCFt
rg
Bank Value  

t
n
(1

r)
(1

r)
t 1
Bank valuation: an application
 Western Plains National Bank (WPNB) is
considering buying 100 percent of Citizens
Trust Bank's stock.
 WPNB's stock price is currently $60 and
Citizens Trust Bank's stock price is $15.
 WPNB’s management is also unwilling to
accept EPS dilution beyond 5 percent.
 Net income for WPNB is forecast to be $22.6
million in 2002, while net income for CTB is
forecast at $5.2 million.
Balance Sheet For Western Plains National Bank (Dollars In Millions)
Assets
Cash and due from banks
Interest bearing deposits with banks
Investment securities:
Treasury & U.S. agency
Corporate & mortgage-backed
Municipals
Total loans and leases
Less reserve for losses
Net loans and leases
Real estate owned
Premises and equipment
Other assets
Total assets
Liabilities
Demand deposits
Savings deposits
Time deposits
Total deposits
Borrowed funds:
Federal funds purchased & RPs
Other borrowed funds
Acceptances and other liabilities
Total liabilities
Stockholders' Equity
Common stock
Paid-in capital
Retained earnings
Total stockholders' equity
Total liabilities and equity
Note: Figures are in millions of dollars.
2000
$ 107
46
% TA
7.0%
3.0%
2001
$ 111
63
% TA
6.9%
3.9%
152
60
71
993
14
$ 979
22
27
62
$ 1,526
10.0%
3.9%
4.7%
65.1%
0.9%
64.2%
1.4%
1.8%
4.1%
100.0%
123
74
67
1,070
17
$ 1,053
27
28
64
$ 1,610
7.6%
4.6%
4.2%
66.5%
1.1%
65.4%
1.7%
1.7%
4.0%
100.0%
$0
$ 235
358
504
$ 1,097
15.4%
23.5%
33.0%
71.9%
$0
$ 240
369
549
$ 1,158
14.9%
22.9%
34.1%
71.9%
$ 166
113
48
$ 1,424
10.9%
7.4%
3.1%
93.3%
166
128
52
$ 1,504
10.3%
8.0%
3.2%
93.4%
$ 10
40
52
$ 102
$ 1,526
0.7%
2.6%
3.4%
6.7%
100.0%
10
40
56
$ 106
$ 1,610
0.6%
2.5%
3.5%
6.6%
100.0%
Income Statement For Western Plains National Bank (Dollars In
Millions)
Interest Income
Loans and losses (includes fees)
Interest-bearing deposits
Treasury & U.S. agency securities
Corporate & mortgage backed securities
Municipals
Total interest income
Interest Expense
Deposits
Federal funds purchased & RPs
Other borrowed funds
Total interest expense
Net Interest Income
Provisions for loan losses
Net interest for income after provisions
NonInterest Income
NonInterest Expense
Salaries & benefits
Other expense
Total noninterest expense
Income before taxes
Provision for income taxes (avg tax rate)
Net Income
Dividends paid to Parent
Retained Earnings
Note: Figures are in millions of dollars.
2000
$ 97.9
2.3
7.9
4.1
3.0
$ 115.2
43.1
7.6
6.8
57.5
57.7
4.9
52.8
30.5
32.0
35.1
$ 67.1
16.1
3.4
$ 12.7
$0
$13
Rate
10.0%
5.0%
5.2%
6.8%
4.2%
Rate
5.0%
4.6%
6.0%
% TL
0.5%
% TA
2.0%
2.1%
2.3%
21.0%
2001
$ 89.5
2.2
4.6
3.9
2.1
$ 102.3
29.4
5.0
5.4
39.7
62.5
5.3
57.3
32.2
30.6
35.4
$ 66.0
23.5
4.8
$ 18.6
$15
$4
Rate
8.5%
3.5%
3.7%
5.3%
3.1%
Rate
3.2%
3.0%
4.2%
% TL
0.5%
% TA
2.0%
1.9%
2.2%
20.5%
Balance Sheet For Citizens Trust Bank (Dollars In Millions)
Historical
2000
Assets
Cash and due from banks
lnterest bearing deposits with
banks
Investment securities:
Treasury & U.S. agency
Corporate & mortgage backed
Municipals
Total loans and leases
Less reserve for losses
Net loans and leases
Real estate owned
Premises and equipment
Other assets
Total assets
2001
$ 000
$23
% TA
7.1%
$ 000
$23
% TA
6.9%
$18
5.4%
$19
5.5%
$40
$17
$19
$187
$3
$184
$3
$7
$14
$324
12.3%
5.2%
5.7%
57.7%
1.0%
56.8%
1.0%
2.1%
4.4%
100.0%
$40
$18
$20
$196
$4
$192
$4
$7
$15
$338
11.8%
5.4%
5.9%
58.0%
1.1%
56.9%
1.1%
2.2%
4.3%
100.0%
$67
$99
$97
$263
20.7%
30.5%
30.0%
81.2%
$70
$106
$103
$279
20.8%
31.3%
30.5%
82.6%
$21
$3
$5
$292
6.5%
1.0%
1.5%
90.2%
$14
$4
$5
$302
4.0%
1.3%
1.6%
89.5%
Stockholders Equity
Common stock
$15
Retained earnings
$17
Total stockholders' equity
$32
Total liability and equity
$324
Note: Figures are in millions of dollars.
4.6%
5.2%
9.9%
100%
$15
$21
$36
$338
4.4%
6.1%
10.5%
100.0%
Liabilities
Demand deposits
Savings deposits
Time deposits
Total deposits
Borrowed funds:
Federal funds purchased & RPs
Other borrowed funds
Acceptances and other liabilities
Total liabilities
Income Statement for Citizens Trust Bank (Dollars in
Millions)
Interest income
Loans and losses (includes fees)
Interest-bearing deposits
Treasury & U.S. agency securities
Corporate & mortgage backed securities
Municipals
Total interest income
Interest Expense
Deposits
Federal funds purchased & RPs
Other borrowed funds
Total interest expense
Net interest income
Provisions for loan losses
Net interest income after provisions
Noninterest income
NonInterest Expense
Salaries & benefits
Other expense
Total noninterest expense
Income before taxes
Provision for income taxes (avg. tax rate)
Net income
Note: Figures are in millions of dollars.
2000
$ 000
Rate
$16.2
8.8%
$0.7
4.1%
$1.7
4.2%
$1.3
7.8%
$0.7
3.9%
$20.6
$7.3
$0.9
$0.2
$8.4
$12.3
$0.9
$11.3
$6.2
$6.5
$6.5
$13.0
$4.5
$0.6
$3.9
Rate
3.7%
4.5%
5.9%
% TA
0.5%
1.9%
2.0%
2.0%
13.8%
2001
$ 000
$15.2
$0.6
$1.3
$1.2
$0.7
$19.0
$6.3
$0.5
$0.2
$7.0
$12.0
$1.2
$10.9
$6.8
$6.4
$7.1
$13.5
$4.1
$0.6
$3.5
Rate
7.9%
3.2%
3.3%
6.8%
3.3%
Rate
3.0%
3.6%
5.0%
% TA
0.6%
2.0%
1.9%
2.1%
13.9%
Summary profit, dividend, asset, deposit
and equity data for WPNB and CTB
A. Summary Profit and Dividend Figures
WPNB
2000
Number of shares
outstanding
Net income
Dividends
Total assets
Deposits
Excess Equity Calculation
Book value of equity
Pro forma equity / Tot assets
Implied normalized equity
Implied excess equity
4,000,000
$ 12,743,490
$
5,000,000
$1,526,000,000
$1,097,000,000
Per
Share
$ 3.19
$ 1.25
$381.50
$274.25
$ 102,000,000 $ 25.50
CTB
2001
4,000,000
$ 18,645,135
$ 14,916,108
$1,610,000,000
$1,158,000,000
Per
Share
2000
Per
Share
2001
3,000,000
$ 3,545,737
$ 1,950,000
$337,932,000
$279,131,832
$ 4.66
$ 3.73
$402.50
$289.50
3,000,000
$ 3,905,666
$ 1,950,000
$324,000,000
$263,107,786
$ 1.30
$ 0.65
$108.00
$ 87.70
$ 105,729,027 $ 26.43
$ 32,000,000
$ 10.67
$ 32,000,000
$ 10.67
Per
Share
$ 1.18
$ 0.65
$112.64
$ 93.04
$ 35,545,737 $ 11.85
8.00%
$ 27,034,560 $ 9.01
$ 8,511,177 $ 2.84
Performance Ratios for WPNB,
Citizens Trust, and Peer Banks
Citizens
Trust
ROE
10.04%
ROA
1.06%
Equity multiplier
9.50x
Profit margin (Net income/Total revenue)
13.87%
Expense ratio (expenses excluding taxes / TA)
6.39%
Asset utilization (Total revenue/Total assets)
7.62%
Yield on earning assets
6.58%
Cost of funding earning assets
2.40%
Net interest margin
4.17%
Interest expense/Total assets
2.05%
Noninterest expense/Total assets
4.00%
Provisions for loan losses/Total assets
0.34%
Efficiency ratio
71.83%
Interest income/Total assets
5.62%
Noninterest income/Total assets
2.00%
Earning assets/Total assets
85.50%
Peer
Group:
$300M to
$500M in
Assets
13.41%
1.28%
10.58x
14.22%
7.18%
9.00%
7.87%
3.50%
4.37%
3.19%
3.64%
0.35%
62.14%
7.19%
1.77%
90.87%
WPNB
17.63%
1.16%
15.23x
13.87%
6.89%
8.35%
7.41%
2.88%
4.53%
2.47%
4.10%
0.33%
69.68%
6.35%
2.00%
85.71%
Peer
Group:
$1B to
$10B in
Assets
13.77%
1.31%
10.25x
14.00%
7.35%
9.36%
7.76%
3.45%
4.31%
3.09%
3.60%
0.66%
55.75%
6.95%
2.35%
89.27%
Comparable acquisition analysis data
2001 Transaction Multiples
Transaction Group
National Medians
(All transactions)
Southern Banks, Assets between $100
MM and $1.0 billion
All Banks between $100MM and
$1.0B and ROA Greater than 1.25%
All Banks between $100MM and
$1.0B and Equity/Assets Greater
than 10%
Number Price /
of
EPS Price / Price / Price /
Trans. (LTM) Book Assets Deposits
Implied Per Share Values
Citizens Trust Bank
Price /
EPS
(LTM)
Price /
Book*
Price /
Assets
Price /
Deposits
240
18.90
1.65
0.17
0.20
$22.34
$17.72
$18.86
$18.93
42
19.62
2.06
0.19
0.24
$23.19
$21.39
$21.41
$22.42
31
16.62
2.16
0.21
0.26
$19.64
$22.30
$24.13
$24.18
36
19.01
1.49
0.20
0.25
$22.47
$16.25
$22.04
$23.35
High 19.62 216.0% 21.42%
Average 18.54 184.0% 19.19%
Median 18.96 185.5% 19.29%
Low 16.62 148.9% 16.74%
*Normalized book value, assuming 8 percent equity as
'normal.'
Source: SNL Securities, 2002.
Southern US includes: AL, AR, FL, GA, LA, MS, NC, OK, SC, TN, TX,
VA and WV
25.99%
23.89%
24.60%
20.35%
23.19
$21.91
22.41
19.64
$22.30
$19.42
$19.56
$16.25
$24.13
$21.61
$21.73
$18.86
$24.18
$22.22
$22.89
$18.93
Comparable companies analysis data
Statistics on Comparable Companies
Citizens Trust Bank
Multiple of Market Value
Per Share
Implied Per Share Equity Value
LTM
High
Low
Mean
Median
ActualValues 3,000,000
High
Low
Mean Median
Total Assets
0.359x
0.093x
0.162x
0.152x
$337,932,000
112.64
40.44
10.48 18.25
17.12
Tangible Book Value*
2.490x
1.155x
1.688x
1.719x
$35,545,737
11.85
25.28
13.25 18.05
18.33
LTM EPS
85.000x 10.131x 17.181x
13.085x
$3,545,737
1.182 100.46
11.97 20.31
15.47
2002 Est EPS
28.333x
9.350x 13.037x
12.195x
$5,172,415
1.724
48.85
16.12 22.48
21.03
2003 Est EPS
14.856x
8.611x 11.288x
11.255x
$5,883,841
1.961
29.14
16.89 22.14
22.07
*Normalized book value, assuming 8 percent equity as 'normal.'
Source: SNL Securities, 2002 (Pricing as of 3/25/2002).
Summary of 21 comparable banking companies with similar assets, capital and profitability
characteristics.
Valuation based on alternative procedures
 Stockholders’ equity at CTB at the end of 2001 is $35.5
million, or $11.85 per share.
 WPNB’s book value per share equals $26.43 in 2001.
Comparable Companies Analysis: Valuing Minority Interests
Price/Share
Premium over Book
Pta
= $17.12 = (0.152) x $112.64
44.48%
Pbvnorm = $18.33= (1.719) x $9.01 + 2.84
54.68%
Peps
30.55%
= $15.47 = (13.085) x $1.182
Comparable Acquisitions Analysis: Valuing Controlling Interest
Price/Share
Premium over Book
Pta
= $21.73 = (0.193) x $112.64
83.38%
Pbvnorm = $19.56 = (1.855) x $9.01 + 2.84
65.06%
Peps
Ptd
89.11%
93.16%
= $22.41 = (18.96) x $1.182
= $22.89 = (0.246) x $93.04
EPS Dilution
 SNB’s management has stipulated that dilution
will not be allowed to exceed 5 percent.
 EPS for WPNB is expected to be $5.65 ($22.6
million / 4 million) in 2002.

This constraint means that EPS of the
consolidated bank after acquisition cannot fall
below $5.37:
($5.65 - consolidated EPS)
 0.05
$5.65
or consolidated EPS = 5.3675
Exchange ratios consistent with the four
valuation procedures
Valuing Minority Interests
Pta
$17.12

 0.2853
MPa
$60
Pbv
$18.33

 0.3055
MPa
$60
Peps
$15.47

 0.2578
MPa
$60
Valuing Controlling Interest
Pta
$21.73

 0.3622
MPa
$60
Pbv
$19.56

 0.3260
MPa
$60
Peps $22.41

 0.3735
MPa
$60
Ptd
$22.89

 0.3815
MPa
$60
Discounted cash flow approach
 Assets at CTB are expected to grow at 10 and 11





percent in 2002 and 2003, respectively.
 Asset growth is expected to slow to 7% and then 5
percent by 2005 and thereafter.
The percentage of assets in net loans at CTB is
expected to increase from 57.5% to 60% by 2004.
Interest rates are expected to increase somewhat
CTB is expected to control noninterest expenses and
increase noninterest income slightly.
Return on equity is projected to be 17.4%, 17.8%, and
18.25% percent from 2002 to 2004, respectively.
 Return on equity is expected to be approximately
18.4% from 2005 and beyond.
CTB is expected to maintain a minimum capital-toasset ratio of 8%.
Earnings available to WPNG after
required additions to capital
Dividends paid to Parent
Dividends per share to Parent
Growth in earnings to parent
Required return
Present Value of
Dividends per share to Parent
2002
$ 10.98
$ 3.66
#N/A
15%
2003
$ 2.61
$ 0.87
-76.21%
15%
2004
$ 4.13
$ 1.38
58.23%
15%
2005
$ 5.06
$ 1.69
22.30%
15%
2006
$ 5.31
$ 1.77
5.00%
15%
2007
$ 5.57
$ 1.86
5.00%
15%
$ 3.18
$ 0.66
$ 0.91
$ 0.96
$ 0.88
$ 0.80
 Growth in earnings available to WPNB (the parent
bank) stabilizes at 5% in 2006
 break the problem into two parts:


explicit forecast period, 2002 through 2005
implicit forecast period, from 2006 and beyond
 earnings are expected to grow at approximately 5 percent
beyond 2005

bank’s required return is 15%
 The market value of equity is $45.39 million or
$15.13 per share:
1.77


3.66 0.87 1.38 1.69  0.15  0.05
Bank Valueper share  $ 15.83 




1.15 1.152 1.153 1.154
1.154
Pro forma balance sheet for Citizens Trust Bank
Proforma
2002
2003
% TA
6.0%
$25
6.0%
11.5%
5.0%
6.0%
59.5%
2.0%
57.5%
1.1%
2.3%
4.3%
100.0%
$41
$21
$25
$253
$8
$244
$5
$10
$18
$413
$78
$119
$121
$318
21.0%
32.1%
32.5%
85.6%
$8
$4
$11
$342
Stockholders Equity
Common stock
$15
Retained earnings
$15
Total stockholders' equity
$30
Total liability and equity
$372
Note: Figures are in millions of dollars.
Liabilities
Demand deposits
Savings deposits
Time deposits
Total deposits
Borrowed funds:
Federal funds purchased & RPs
Other borrowed funds
Acceptances and other liabilities
Total liabilities
% TA
6.5%
$
000
$25
$22
5.8%
$43
$19
$22
$221
$7
$214
$4
$9
$16
$372
2004
$
000
$26
Assets
Cash and due from banks
lnterest bearing deposits with
banks
Investment securities:
Treasury & U.S. agency
Corporate & mortgage backed
Municipals
Total loans and leases
Less reserve for losses
Net loans and leases
Real estate owned
Premises and equipment
Other assets
Total assets
$
000
$24
2005
% TA
6.0%
$
000
$28
$27
6.2%
10.0%
5.0%
6.0%
61.2%
2.0%
59.2%
1.1%
2.4%
4.3%
100.0%
$40
$22
$26
$274
$9
$265
$5
$11
$19
$441
$87
$132
$134
$353
21.0%
32.1%
32.5%
85.6%
2.2%
1.2%
3.0%
92.0%
$9
$5
$12
$380
4.0%
4.0%
8.0%
100.0%
$15
$18
$33
$413
2006
% TA
6.0%
$
000
$29
$29
6.2%
9.0%
5.0%
6.0%
62.0%
2.0%
60.0%
1.1%
2.5%
4.3%
100%
$42
$23
$28
$287
$9
$278
$5
$12
$20
$464
$93
$142
$143
$378
21.0%
32.1%
32.5%
85.6%
2.2%
1.2%
3.0%
92.0%
$10
$5
$13
$406
3.6%
4.4%
8.0%
100.0%
$15
$20
$35
$441
2007
% TA
6.0%
$
000
$31
% TA
6.0%
$30
6.2%
$32
6.2%
9.0%
5.0%
6.0%
62.0%
2.0%
60.0%
1.1%
2.5%
4.3%
100%
$44
$24
$29
$302
$10
$292
$5
$12
$21
$487
9.0%
5.0%
6.0%
62.0%
2.0%
60.0%
1.1%
2.5%
4.3%
100%
$46
$26
$31
$317
$10
$307
$6
$13
$22
$511
9.0%
5.0%
6.0%
62.0%
2.0%
60.0%
1.1%
2.5%
4.3%
100%
$97
$149
$151
$397
21.0%
32.1%
32.5%
85.6%
$102
$156
$158
$417
21.0%
32.1%
32.5%
85.6%
$107
$164
$166
$437
21.0%
32.1%
32.5%
85.6%
2.2%
1.2%
3.0%
92.0%
$10
$6
$14
$426
2.2%
1.2%
3.0%
92.0%
$11
$6
$15
$448
2.2%
1.2%
3.0%
92.0%
$11
$6
$15
$470
2.2%
1.2%
3.0%
92.0%
3.4%
4.6%
8.0%
100.0%
$15
$22
$37
$464
3.2%
4.8%
8.0%
100.0%
$15
$24
$39
$487
3.1%
4.9%
8.0%
100.0%
$15
$26
$41
$511
2.9%
5.1%
8.0%
100.0%
Pro forma income statement for Citizens Trust Bank
Interest income
Loans and losses (includes fees)
Interest-bearing deposits
Treasury & U.S. agency securities
Corporate & mortgage backed
securities
Municipals
Total interest income
Interest Expense
Deposits
Federal funds purchased & RPs
Other borrowed funds
Total interest expense
Net interest income
Provisions for loan losses
Net interest income after provisions
Noninterest income
NonInterest Expense
Salaries & benefits
Other expense
Total noninterest expense
Income before taxes
Provision for income taxes (avg. tax rate)
Net income
2002
$ 000
$17.5
$0.8
$2.3
$1.3
$0.8
$22.7
$8.2
$0.3
$0.2
$8.7
$14.0
$1.3
$12.7
$8.2
$7.1
$7.8
$14.9
$6.0
$0.8
$5.2
Rate
8.2%
3.6%
5.3%
7.1%
3.7%
Rate
3.3%
3.8%
5.4%
% TA
0.6%
2.2%
1.9%
2.1%
13.9%
2003
$ 000
$20.8
$1.0
$2.3
$1.5
$1.0
$26.6
$10.2
$0.4
$0.3
$10.8
$15.7
$1.5
$14.3
$9.1
$7.8
$8.7
$16.5
$6.8
$0.9
$5.9
Rate
8.5%
3.9%
5.6%
7.4%
4.0%
Rate
3.7%
4.1%
5.6%
% TA
0.6%
2.2%
1.9%
2.1%
13.9%
2004
$ 000
$22.5
$1.1
$2.2
$1.6
$1.1
$28.5
$10.8
$0.4
$0.3
$11.5
$17.0
$1.6
$15.4
$9.7
$8.4
$9.3
$17.7
$7.5
$1.0
$6.4
Rate
8.5%
3.9%
5.6%
7.4%
4.0%
Rate
3.7%
4.1%
5.6%
% TA
0.6%
2.2%
1.9%
2.1%
14.0%
2005
$ 000
$23.6
$1.1
$2.3
$1.7
$1.1
$29.9
$11.3
$0.4
$0.3
$12.0
$17.9
$1.7
$16.3
$10.2
$8.8
$9.7
$18.5
$7.9
$1.1
$6.8
Rate
8.5%
3.9%
5.6%
7.4%
4.0%
Rate
3.7%
4.1%
5.6%
% TA
0.6%
2.2%
1.9%
2.1%
14.0%
2006
$ 000
$24.8
$1.2
$2.5
$1.8
$1.2
$31.4
$11.8
$0.4
$0.3
$12.6
$18.8
$1.8
$17.1
$10.7
$9.2
$10.2
$19.5
$8.3
$1.2
$7.2
Rate
8.5%
3.9%
5.6%
7.4%
4.0%
Rate
3.7%
4.1%
5.6%
% TA
0.6%
2.2%
1.9%
2.1%
14.0%
2007
$ 000
$26.1
$1.2
$2.6
$1.9
$1.2
$33.0
$12.4
$0.5
$0.3
$13.2
$19.8
$1.8
$17.9
$11.2
$9.7
$10.7
$20.4
$8.7
$1.2
$7.5
Note: Figures are in millions of dollars.
Growth in Total Assets
Return on Equity
Return on Assets
Retained Earnings
Dividends paid to Parent
Dividend per-share to parent
Growth in earnings to parent
Required return
Present Value of Dividends per share to
Parent
10.0%
17.4%
1.39%
-5.81
10.98
3.66
#N/A
15.0%
11.0%
17.8%
1.43%
3.27
2.61
0.87
-76.2%
15.0%
3.18
0.66
7.0%
18.25%
1.46%
2.31
4.13
1.38
58.23%
15.0%
0.91
5.0%
18.40%
1.47%
1.77
5.06
1.69
22.30%
15.0%
0.96
5.0%
18.40%
1.47%
1.85
5.31
1.77
5.00%
15.0%
0.88
5.0%
18.40%
1.47%
1.95
5.57
1.86
5.00%
15.0%
0.80
Rate
8.5%
3.9%
5.6%
7.4%
4.0%
Rate
3.7%
4.1%
5.6%
% TA
0.6%
2.2%
1.9%
2.1%
14.0%
Merger pricing implications
 The previous analysis suggests a range of potential
prices for CTB stock.
 The final resolution will depend on the negotiating
strength of each party as well as nonfinancial
considerations that have not been addressed.
 The relationships observed among the various
procedures are representative of results in many
applications.



From an economic perspective, the present value
approach often produces the lowest price estimate.
If a transaction can be negotiated close to this price, the
acquirer will experience the smallest EPS dilution and
will be able to reach its earnings objectives soonest.
Not surprisingly, sellers prefer to focus on historical
premium-to-book value and premium-to-earnings
valuation approaches.
Buyers and sellers have important nonprice
objectives.
 Buyers typically want to
 Avoid postmerger financial and operational
complications.
 Retain the best employees of the acquired bank.
 Keep the acquired bank’s best customers.
 Maintain the beneficial aspects of the acquired
bank’s culture.
 Sellers, in a friendly transaction, typically:
 Want to walk away from the deal without any
residual risk.
 Want to be indemnified against yet-unrevealed
liabilities or losses that might arise from
decisions under their tenure.
 Are primarily concerned with the size of the
premium offered.
Bank Management, 5th edition.
Timothy W. Koch and S. Scott MacDonald
Copyright © 2003 by South-Western, a division of Thomson Learning
BANK MERGERS
AND ACQUISITIONS
Chapter 22