Financial Services Firms: Governance, Regulations, Valuations, Mergers, and Acquisitions, Third Edition PDF
Preview Financial Services Firms: Governance, Regulations, Valuations, Mergers, and Acquisitions, Third Edition
Financial Services Firms Governance, Regulations, Valuations, Mergers, and Acquisitions Third Edition ZABIHOLLAH REZAEE JohnWiley&Sons,Inc. Copyright#2001,2011byJohnWiley&Sons,Inc.Allrightsreserved.Secondedition2001 Thirdedition2011 PublishedbyJohnWiley&Sons,Inc.,Hoboken,NewJersey. PublishedsimultaneouslyinCanada. Nopartofthispublicationmaybereproduced,storedinaretrievalsystem,ortransmittedinany formorbyanymeans,electronic,mechanical,photocopying,recording,scanning,orotherwise, exceptaspermittedunderSection107or108ofthe1976UnitedStatesCopyrightAct,without eitherthepriorwrittenpermissionofthePublisher,orauthorizationthroughpaymentofthe appropriateper-copyfeetotheCopyrightClearanceCenter,Inc.,222RosewoodDrive,Danvers, MA01923,(978)750-8400,fax(978)646-8600,orontheWebatwww.copyright.com. RequeststothePublisherforpermissionshouldbeaddressedtothePermissionsDepartment, JohnWiley&Sons,Inc.,111RiverStreet,Hoboken,NJ07030,(201)748-6011,fax(201)748- 6008,oronlineatwww.wiley.com/go/permissions. LimitofLiability/DisclaimerofWarranty:Whilethepublisherandauthorhaveusedtheirbest effortsinpreparingthisbook,theymakenorepresentationsorwarrantieswithrespecttothe accuracyorcompletenessofthecontentsofthisbookandspecificallydisclaimanyimplied warrantiesofmerchantabilityorfitnessforaparticularpurpose.Nowarrantymaybecreatedor extendedbysalesrepresentativesorwrittensalesmaterials.Theadviceandstrategiescontained hereinmaynotbesuitableforyoursituation.Youshouldconsultwithaprofessionalwhere appropriate.Neitherthepublishernorauthorshallbeliableforanylossofprofitoranyother commercialdamages,includingbutnotlimitedtospecial,incidental,consequential,orother damages. Forgeneralinformationonourotherproductsandservicesorfortechnicalsupport,please contactourCustomerCareDepartmentwithintheUnitedStatesat(800)762-2974,outsidethe UnitedStatesat(317)572-3993orfax(317)572-4002. Wileyalsopublishesitsbooksinavarietyofelectronicformats.Somecontentthatappearsin printmaynotbeavailableinelectronicbooks.FormoreinformationaboutWileyproducts,visit ourwebsiteatwww.wiley.com. LibraryofCongressCataloging-in-PublicationData: Rezaee,Zabihollah,1953- Financialservicesfirms:governance,regulations,valuations,mergers,andacquisitions/ ZabihollahRezaee.—3rded. p.cm. Rev.ed.of:Financialinstitutions,valuations,mergers,andacquisitions.2nded.NewYork: J.Wiley,c2001. Includesindex. ISBN978-0-470-60447-2(hardback);978-1-118-09851-6(ebk);978-1-118-09852-3 (ebk);978-1-118-09853-0(ebk) 1. Banksandbanking–Valuation–UnitedStates. 2. Bankmergers–UnitedStates. 3. Sale ofbanks–UnitedStates. 4. Financialinstitutions–Valuation–UnitedStates. 5. Financial institutions–Mergers–UnitedStates. 6. Financialinstitutions–Purchasing–United States. 7. Consolidationandmergerofcorporations–Lawandlegislation–United States. I. Rezaee,Zabihollah,1953- Financialinstitutions,valuations,mergers,and acquisitions. II. Title. HG1707.7.R492011 0 332.16–dc22 2011012029 PrintedintheUnitedStatesofAmerica 10 9 8 7 6 5 4 3 2 1 To the loving memory of my mother, Fatemeh Rezaee. Contents Preface xi Acknowledgments xvii PARTI:FINANCIALSERVICESINDUSTRY:ITSMARKETS, REGULATIONS,ANDGOVERNANCE 1 Chapter1:FundamentalsoftheFinancialMarkets andInstitutions 3 Introduction 3 FinancialMarkets 3 FinancialInformationandCapitalMarkets 4 FinancialCrisisandFinancialRegulatoryReforms 5 TypesandRolesofFinancialMarkets 15 FinancialServicesFirms 21 Conclusion 24 Notes 25 Chapter2:IntroductiontoFinancialInstitutions 27 Introduction 27 LandscapeoftheFinancialServicesIndustry 27 StructuralChangesintheFinancialServicesIndustry 28 HistoricalPerspectiveofAmericanBanking 42 CurrentTrendsintheFinancialServicesBankingIndustry 43 RegulatoryReforms 46 ValuationProcess 55 Conclusion 56 Notes 57 Chapter3:CorporateGovernance 61 Introduction 61 CorporateGovernanceEffectiveness 62 GlobalRegulatoryReforms 66 Sarbanes-OxleyActof2002 70 Dodd-FrankAct 74 CorporateGovernanceFunctions 75 v vi & Contents BoardofDirectorsandItsCommittees 78 AuditCommitteeRolesandResponsibilities 80 ExecutiveCompensation 84 Conclusion 86 Notes 86 PARTII:THEFOUNDATION:FINANCIALINSTITUTIONS, VALUATIONS,MERGERS,ACQUISITIONS,AND REGULATORYANDACCOUNTINGENVIRONMENT 89 Chapter4:OverviewoftheValuationProcess 91 Introduction 91 ValuationServices 92 ValuationProfession 94 ValuationoftheBusiness 97 AttractingValuationClients 105 AcceptingaClient 109 PricingValuationServices 111 ImportanceoftheEngagementLetter 112 PlanninganAppraisalEngagement 114 GeneralPlanning 118 Appraiser’sTraits 121 Appraiser’sDueDiligenceProcess 124 RiskAssessment 125 Conclusion 126 Notes 126 Chapter5:OverviewofMergersandAcquisitions 127 Introduction 127 HistoricalPerspectiveofMergersandAcquisitions 128 RecentTrendsinMergersandAcquisitions 130 RegulationsofBankMergers 136 PlayersinMergersandAcquisitions 142 MotivesforBusinessCombinations 146 DeterminantsofMergersandAcquisitions 148 PerceivedShortcomingsofMergersandAcquisitions 152 StudiesonMergersandAcquisitions 155 LeveragedBuyout 159 PostMergersandAcquisitionsPerformance 160 ShareholderWealthandEffectofMergersandAcquisitions 161 JointVenturesandStrategicAlliances 162 EthicsinMergersandAcquisitions 163 GovernanceinMergersandAcquisitions 164 MergersandAcquisitionsProcess 165 Conclusion 181 Notes 183 Contents & vii Chapter6:RegulatoryEnvironmentandFinancialReporting ProcessofFinancialInstitutions 187 Introduction 187 Consolidation 187 RegulatoryEnvironment 192 BankSupervision 198 FinancialModernization:TheGramm-Leach-BlileyAct 205 FinancialReportingProcessofFinancialInstitutions 208 StatementofFinancialAccountingStandardsNo.115 212 AuditingProperClassificationsofMarketableSecurities 214 TaxConsiderationofFairValue 215 RecentDevelopmentofFairValueAccounting 218 FinancialReportingRequirementsofFinancialInstitutions 222 CorporateGovernanceofFinancialInstitutions 228 Conclusion 237 Notes 238 PARTIII:FUNDAMENTALSOFVALUATIONS:CONCEPTS, STANDARDS,ANDTECHNIQUES 241 Chapter7:ValueandValuation:AConceptualFoundation 243 Asset-LiabilityManagement 243 InvestmentManagement 245 LendingManagement 246 LiquidityManagement 247 NatureofValue 249 TwelveConceptsofValue 250 TypesofPropertythatCanBeValued 260 RelationshipamongDifferentTypesofValue 261 PrinciplesofValuationTheory 262 PricingValueversusReportingValue 263 LimitationsoftheValuationProcess 264 Conclusion 264 Notes 264 Chapter8:ApproachestoMeasuringValue 267 OverviewoftheValuationProcess 267 CostApproachtoValuation 268 MarketApproachtoValuation 270 IncomeApproachtoValuation 273 SpecialTopics—ApprochestoIntangibleAssetValuation 291 SpecialTopics—BusinessValuation 294 ValuationandBusinessConcentrations 300 SpecialTopics—CloselyHeldStock 301 SpecialTopics—ValuingWidelyTradedCompanies 304 Conclusion 305 Notes 305 viii & Contents Chapter9:ValuationsforTaxandAccountingPurposes 307 TaxAspectsofMergersandAcquisitions 307 TypicalTax-OrientedValuations 310 AccountingAspectsofMergersandAcquisitions 313 TypicalAccounting-OrientedValuations 319 AcquisitionMethod 320 Presentation,Disclosure,andTransitionRequirementsofBusiness Combinations 324 ConvergenceinAccountingStandardsonMergersandAcquisitions 327 Conclusion 328 Notes 329 Chapter10:IntangibleAssetValuation 331 NatureandTypesofIntangibleAssets 331 AmortizableversusNonamortizableIntangibleAssets 334 MeasuringtheUsefulLifeofanIntangibleAsset 336 EstablishingValueofIntangibleAssets 338 AmortizationMethods 341 SupportingIntangibleAssetValuationandAmortization 341 GoodwillImpairment 342 Conclusion 343 Notes 344 PARTIV:ASSESSMENTOFFINANCIALINSTITUTIONS 345 Chapter11:FinancialAnalysisofBanksandBankHolding Companies 347 TypesandSourcesofFinancialData 347 OverviewofFinancialStatements 351 CompositionofBankAssets 355 CompositionofBankLiabilities 359 Off–BalanceSheetItems 361 CompositionofBankCapital 362 RegulatoryCapitalComponents 364 Risk-BasedCapital 367 Value-at-RiskModels 370 CompositionofBankIncome 371 CompositionofBankExpenses 373 BalanceSheetAnalysisIllustration 376 IncomeStatementandProfitabilityAnalysisIllustration 381 LoanRiskAnalysisIllustration 385 LiquidityandInvestmentPortfolioAnalysisIllustration 389 PortfolioEquitiesAnalysis(REALMModel) 390 SpecialBankHoldingCompanyConsiderations 391 LiabilityManagement 392 Conclusion 392 Notes 392 Contents & ix Chapter12:InternalCharacteristicsAssessment 395 ObjectivesandBenefitsofanInternalCharacteristicsAssessment 396 TenPFactorFramework 396 ShareholderValueCreation 405 Conclusion 412 Notes 413 Chapter13:ExternalEnvironmentAssessment 415 ImpactofExternalEnvironmentonValue 415 PoliticalAnalysis 416 EconomicAnalysis 416 SocialAnalysis 417 TechnologicalAnalysis 420 OtherAnalysis 421 Conclusion 423 Notes 423 PARTV:VALUATIONOFMERGERSANDACQUISITIONS 425 Chapter14:BankMergerandAcquisitionProcess 427 StrategyPhase 427 NegotiationandInvestigationPhase 435 FinalizationandIntegrationPhase 439 OtherConsiderations 443 Conclusion 446 Notes 446 Chapter15:ValuingaBankasaBusinessEnterprise 447 BusinessEnterpriseversusaCollectionofAssets 447 ConceptoftheBankingFranchise 448 DifferencebetweenStrategicandTacticalValuations 449 WhytheCostApproachIsNotUsedforStrategicBankValuations 450 ApplicationoftheMarketApproachtoValuingaBank 450 ApplicationoftheIncomeApproachtoValuingaBank 454 SensitivityofValueEstimatetoAssumptionChanges 461 Value-CreationOpportunitiesandtheAcquisitionPrice 463 ValuationMethodsforMergersandAcquisitions 465 SophisticatedValuationTechniquesforMergersandAcquisitions 470 RelationbetweenPriceandValueandEffectonStockholders 475 Conclusion 478 Notes 478 Chapter16:ValuationofTangibleBankAssets 479 TangiblePhysicalAssets 480 TangibleFinancialAssets 481 TangibleAssetsinBankMergersandAcquisitions 486 x & Contents IntangibleAssetsinBankMergersandAcquisitions 486 Conclusion 487 Chapter17:CoreDepositsasaSpecialTypeofIntangibleAsset Valuation 489 ConceptofCoreDepositBaseasanIntangibleAsset 489 InternalRevenueServicePositiononCoreDeposits 490 ImportantCoreDepositTaxCourtCases 490 DepositstoBeIncludedinValuation 497 AlternativeApproachestoValuingaCoreDepositBase 497 CoreDepositBaseLifeEstimation 499 ApplicationoftheCostSavingsApproach 502 ApplicationoftheFutureIncomeApproach 505 SystemicallyImportantFinancialInstitutions 508 Conclusion 511 Notes 511 Chapter18:DerivativeFinancialInstruments 513 AuthoritativeGuidelinesonDerivatives 515 DerivativeMarkets 516 DerivativesRiskManagement 518 DerivativesRiskManagementPolicy 519 AccountingforDerivatives 528 TaxConsiderationsofDerivatives 535 AuditofDerivativeTransactions 535 SourcesofInformationonDerivatives 537 DerivativesValuationModels 538 DerivativesundertheDodd-FrankActof2010 542 Conclusion 543 Notes 543 Chapter19:Real-WorldBankValuationComplications 547 BanksExperiencingRecentLosses 548 BankswithLowEquityCapital 551 BankswithUncertainFutureLoanLossExposure 554 PreferredandCommonStock 556 HighlyLeveragedBanks 557 BranchAcquisitions 557 EuropeanBankingModel 559 InitialPublicOffering 561 IslamicBankingSystem 562 EmergingIssuesintheFinancialServicesIndustry 564 Conclusion 568 Notes 568 AbouttheAuthor 569 Index 571 Preface T RADITIONALLY, CUSTOMERS HAVE HAD their checking and savings accounts at a bank, their mortgage at the savings and loan association, their insurance services with insurance companies, and their investment activities withinvestingcompanies,mutualfunds,andbrokeragefirms.Thisconventionalmodel of providing and receiving financial services has disappeared in the years after the Gramm-Leach-BlileyFinancialServicesModernizationActof1999.Therecentwaveof consolidations in the financial services industry has resulted in fewer but bigger financial institutions, and they are often perceived as ‘‘too big to fail’’ (TBTF). The distinctions among financial services and products of banks, insurance companies, mutual funds, and brokerage firms are now becoming less noticeable. The principal focus of this book is on banks, but many issues discussed throughout all chapters are relevantforallfirmsinthefinancialservicesindustry,suchasmutualandhedgefunds andinvestmentandinsurancecompanies.Althoughitisnotthepurposeorthisbookto evaluatetherelativeimportanceoffactorsthatcontributedtothe2007–2009financial crisis, their consequences and regulatory responses are discussed. As this book was goingthroughproduction,theFinancialCrisisInquiryCommissionissuedareportthat suggests the 2007–2009 financial crisis could have been avoided and was caused by inadequate and ineffective regulations to ensure the safety and soundness of the financialsystem.Otherfactorswhichcontributedtothecrisisrangefromlaxoversight ofderivativestoinsufficientsupervisionbyfederalbankingandsecuritiesregulatorsas well as greed, excessive risk taking, and mismanagement of executives of financial services firms. A new regulatory framework has been established for the financial services industry, including the Dodd-Frank Act of 2010 and its related regulations, Group of 20 summits, and Basel committee requirements. This new regulatory framework definesboundaries,guidance,andrequirementswithinwhichbanksandotherfinancial servicesfirmscaneffectivelyoperateingeneratingsustainableperformance.Itnormally is supplemented by best practices of vigilant boards of directors, risk assessment, and effective corporate governance. In an open market economy and the free enterprise system,theachievementofsustainableperformancedependsoncost-effectiveandeffi- cientregulationsaswellaseffectivecorporategovernance,bestpractices,andcompe- tentandethicalculture.Thereshouldbearightbalancebetweenrulesandregulations governingbanks’operationsandoversightfunctionsoftheboardtoengageinbusiness strategy and overseeing managerial decisions. xi
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