The US regional banking crisis, which began last March, created a sense of panic that spread to most financial centers, even Europe. Then many investors preferred to resell their shares issued by European banks, although they are solvent and liquid, fearing the impact of contagion.
Indicator KBW Banks, which included US regional banks, then became a benchmark for the health of the sector on the other side of the Atlantic. This Friday, May 19th, the Secretary of State for the Exchequer announces, Janet Yellenthat new inter-bank mergers might be necessary, caused a loss 0.98% in this indicator. At the same time, index Stoxx Bankbased on European banks 0.19%. Therefore, the stock market performance of European banks does not seem to match the performance of American banks. Moreover, the path The National Bank of Paris Paribas finally by 9% Since the beginning of the year, it has been from Credit Agricole by 19%while that of Societe Generale fell 4%.. In the same sector, the performance of the stock market can thus be compared. Far from general trends, the bank’s stock price takes into account the specifics of its economic development plan. The intrinsic method of valuation of industrial and commercial companies by discounting future cash flows cannot be applied to a financial institution. In this context, can the bank be evaluated materially?
For an industrial or commercial firm, the value of its operating assets, or enterprise value, is equal to the sum of the discounted free cash flows that those assets are likely to generate in perpetuity. These streams are generated by operating activity and reduced by investments, net of asset disposals; They are then “free” to be charged with servicing the debt and paying dividends. From an accounting point of view, it is calculated from the total operating surplus, or EBITDA Which, by definition, does not take into account financial income and financial expenditure. Operating assets so valued include fixed assets and working capital requirements.
This approach through discounted cash flows (DCF) It cannot be transferred to banks due to the specifics of their activity. This primarily focuses on credit to individuals, businesses and communities. In addition, the deposits of customers who do not finance loans are placed mainly in bonds. In addition, part, sometimes necessary, of the loans granted is refinanced by debt. Thus, the composition of the bank’s result depends, first of all, on the interest margin, which corresponds to the difference between, on the one hand, the interest received from customers and issuers of the held bonds, and, on the other hand, the interest paid by the bank as part of its refinancing. the net banking income (NBI) equals this interest margin which has been specially increased by the commissions received by the Bank, net of commissions paid and capital gains on securities. So gross operating income (RBE), equal to NBI’s operating expenses minus, does it include, other than EBITDA of a manufacturing or commercial firm, financial income and financial expenses. Thus the idea of cash flow that can be allocated to the disinterest of creditors is inconceivable for the bank because these financial elements, ipso facto, taken into account from the top of the income statement. Moreover, the concepts of operating assets and enterprise value cannot be transferred to the bank. In fact, due to its main business as a lender, the bank’s financial debt cannot be distinguished from operational debt. Therefore the working capital requirement cannot be calculated from the balance sheet of the bank. Similarly, assuming that the value of the enterprise can be obtained, the determination of net debt, which will be discounted to obtain the value of equity, is not possible.
Besides these purely technical aspects, another specificity of the bank must be incorporated into its assessment: the need to comply with regulatory restrictions to maintain the license that allows it to carry out its activity of collecting deposits and taking risks, especially credit. Each country has its own supervisory body, to which the bank must submit its reports every three months, and in particular provide ratios of solvency, liquidity and financial leverage. In France it is Prudential Supervisory Authority and its solution, or ACPR. Moreover, after bankruptcy Lehman BrothersThe G-20 meeting in London in 2009 led to the creation of the Financial Stability Board. The latter then determined which banks are considered systemic and which have also since been placed under control European Central Bank. This is the case, in Francel The National Bank of Paris Paribasl BPCEthe Credit Agricole and Societe Generale.
Historically, supervisory authorities have focused first on solvency ratios. These compare the bank’s equity with the commitments it has made. Each solvency ratio relies on a fairly extensive definition of equity, which may include certain subordinated debts. Level 1 or Level 1 is first brought to the attention of financial analysts and rating agencies Level 1 common stock (CET1) which excludes any secondary debt. Shareholders’ equity is calculated on the basis of shareholders’ equity, the share of the group. They include a portion of minority interest and are reduced in particular by intangible assets, goodwill or good intentionThe expected dividends for the next fiscal year and investments in financial companies. The liabilities are weighted according to the risks assumed by the bank. Credit risk, in general, is the main risk to which a bank is exposed. Then its weighting includes the possibility of bankruptcy of the counterparty. By way of illustration, as of March 31, 2022, the CET1 lineage From BNP Paribas, Crédit Agricole Group and Société Générale respectively 13.6%, 17.6%, 13.5%.
The first pillar of prudential regulation states that CET1 ratio It must equal at least 4.5%. But the second pillar adds prudential “cushions” that are specific to each bank and change each year. For example, after taking these buffers into account, the minimum percentage of CET1 in Société Générale was 9.3% as of December 31, 2022. On that date, her CET1 percentage 13.5% exceeded this target by 4.2 percentage points.
The significance of the CET1 ratio leads practitioners to incorporate it into the Bank’s material assessment. This is then based on the approach of discounting future earnings forever or Dividend discount form (MDD). Dividends taken into account are not those that will actually be paid to shareholders. It is the excess of CET1 in relation to the solvency requirement that could, in theory, lead to distribution. For example, CET1 of the bank, and its obligations Weighted 1.000 And who has a goal 10% percentage of CET1, must reach 100. If its CET1 is 120 on December 31, the bank has a CET1 surplus of 20 that can theoretically be distributed. This calculation is then made for each subsequent fiscal year. As in the context of the DCF model, a business plan is drawn up over a period of 3 to 5 years and mechanically extended, on the basis of some key indicators, over an additional 3 to 5 years. The equity value of the bank will then be equal to the sum of the two components. The first is the sum of theoretical profits discounted over the life of the business plan; The second is the terminal value which is based on a reasonable assumption, in line with market expectations, of theoretical earnings annual growth in perpetuity.
Since the discount relates to dividends, which, in essence, are discounted from the profit including the financial result, the discount rate is the cost of equity. The latter is determined from the Financial Asset Valuation Model (MEDAF). Thus, it is equal to the risk-free rate increased by the bank’s share risk premium which by itself is equal to the bank’s beta multiplied by the market risk premium.
So it is possible to evaluate the bank substantially. To do this, it is enough to have a business plan and update, forever, future theoretical dividends, the amounts of which are derived from excess hedge capital. This approach avoids the use of the discounted cash flow method, which is not suitable for financial institutions, given the solvency constraints of the bank.
Olivier Levin is an affiliate professor at HEC Paris
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