Valuing a bank : under IFRS and Basel III

313 Pages·2011·2.748 MB·English

by  Grier, Waymond A.

Valuing a Bank
Under IFRS and Basel III
Second Edition

Valuing a Bank
Under IFRS and Basel III
Second Edition
Waymond A Grier
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Published by
Euromoney Institutional Investor PLC
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Copyright © 2011 Euromoney Institutional Investor PLC
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Contents
Preface xi
About the author xvi
Module 1: The process of valuing a bank 1
Introduction 1
Why banks merge 6
How mergers add value 7
What makes a merger unattractive? 8
Exercise 1.1 9
Three-stage approach 9
Market value approach 14
Equity value approach 16
Exercise 1.2 17
Bank risks 17
Exercise 1.3 19
Summary 20
Module 2: IFRS disclosure for banks 21
Introduction 21
Applicable IFRS standards 21
Consolidated statement of income 21
Exercise 2.1 22
Consolidated statement of comprehensive income 26
Consolidated statement of financial position (balance sheet) – assets 27
Consolidated statement of financial position (balance sheet) – liabilities 27
Consolidated changes to equity 31
Consolidated statement of cash flows 31
Disclosure requirements for banks and similar institutions 31
Exercise 2.2 34
Maturities of assets and liabilities 34
IAS 39/IFRS 9 and hedging asset/liability mismatch 37
Concentration of assets, liabilities and off-balance-sheet items 40
Related-party transactions 42
Other disclosures 42
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Contents
Merger accounting for banks 43
Exercise 2.3 46
Summary 47
Module 3: Book to market value 48
Introduction 48
FMV and a bank’s assets and liabilities 49
Exercise 3.1 51
Cash and cash equivalents 51
Financial instruments 51
Treasury bills and other eligible bills 52
Trading and repo securities 52
Derivatives (as assets) 53
Exercise 3.2 56
Exercise 3.3 57
Other placements 57
Investment securities 57
Pledged assets 58
Loans and advances to customers 58
Customer liability for acceptances 63
Lease financing 63
Exercise 3.4 64
Real estate loans 64
Exercise 3.5 66
Reserve for loan losses 66
Investments in subsidiaries 66
Intangible assets 67
Bank premises and equipment 67
Deferred tax assets 68
Other assets 68
Deposits 68
Derivatives (as liabilities) 70
Short-term borrowed funds 71
Other borrowed funds 71
Current and deferred tax liabilities 72
Retirement benefit obligations 72
Equity 73
Exercise 3.6 74
Off-balance-sheet items 74
Exercise 3.7 76
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Contents
Case study example of book value to fair market value 77
Annex: Example of a cash flow hedge (a ‘plain vanilla’ interest rate
swap) 77
Module 4: Market valuation models 84
Introduction 84
Model basis 84
Due from banks: interest-bearing time deposits 86
Exercise 4.1 87
Other money market placements: overnight funds 87
Exercise 4.2 87
Treasury bills and other eligible bills 87
Treasury notes 88
Coupon versus discount rate 89
Exercise 4.3 90
Treasury notes: market valuation between coupon dates 90
Treasury bonds 91
Zero-coupon bonds 92
Discount rate and price 92
Bond price over time (interest-paying bond) 92
Securities purchased under agreement to resell (repos) 93
Loans 94
Reserve for loan losses 101
Other assets 101
Model summary for assets 101
Exercise 4.4 102
Exercise 4.5 102
Model usage for liabilities 102
Off-balance-sheet items 104
Summary 104
Module 5: Cash flow valuation for banks 106
Introduction 106
The equity approach 107
Exercise 5.1 109
Estimating free cash flow 109
Step 1: identifying the relevant components of free cash flow 111
Step 2: developing an integrated historical perspective 112
Step 3: forecasting changes in net interest income and developing
the forecast assumptions 115
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Contents
Step 4: calculating and evaluating the resulting free cash flow
forecast 119
Exercise 5.2 123
Exercise 5.3 123
Module 6: GAP value drivers 127
Introduction 127
Static GAP analysis 127
Dynamic GAP analysis 127
Exercise 6.1 128
Determinants of rate sensitivity 128
Factors affecting net interest income (NII) 129
Changes in the level of interest rates 130
Changes in the relationship between short-term asset yields and
liability costs 134
Changes in volume 134
Changes in portfolio composition 134
Rate sensitivity reports 135
Strengths and weaknesses: GAP analysis 137
Managing the GAP 138
Link between GAP and NIM 140
Sensitivity and simulation analysis 142
The duration gap: managing the market value of equity 144
Exercise 6.2 146
A duration application for banks 146
An immunised portfolio 150
GAP versus duration gap: which model is better? 151
Macrohedging and the GAP 152
Hedging and duration gap 154
Summary 155
Note: classification of cash and current account
(non-interest-bearing) deposits 156
Exercise 6.3 157
Module 7: Equity value application 158
Introduction 158
Free cash flow valuation 158
The capital asset pricing model (CAPM) 158
The dividend valuation model 163
Targeted return on equity (ROE) 165
Exercise 7.1 166
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Contents
Case application: valuing the free cash flow to shareholders 166
Other valuation procedures 166
EPS dilution constraints 173
Exercise 7.2 174
Case application 175
Non-financial considerations that affect mergers and acquisitions 183
Summary 184
Exercise 7.3 185
Module 8: Enhancing bank value in reformed markets 186
Introduction 186
Types of credit derivatives 187
Credit default swaps 189
Exercise 8.1 196
Exercise 8.2 196
Total return swaps 197
Exercise 8.3 203
Credit-linked notes 203
Exercise 8.4 207
Summary 207
Module 9: Basel III and bank value 209
Introduction 209
Definitions of capital 210
Regulatory capital: Bank for International Settlements 210
Basel I, Basel II and Basel III 211
Credit risk 216
Market risk 218
Operational risk 219
Exercise 9.1 220
Pillars 2 and 3 224
Internal growth rate of capital (IGRC) 224
Supplementary traditional capital ratios 226
Can shareholder value be added under Basel III? 226
Factors motivating regulatory capital arbitrage 227
Capital arbitrage in practice 230
Summary 230
Module 10: Value in stress testing and early warning signs 231
Part 1 Stress testing and value 231
What is a stress test? 231
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