According to the US Census Bureau, the commercial banking industry (NAICS 522110) is comprised of establishments primarily engaged in accepting demand and other deposits and making commercial, industrial, and consumer loans. It is a global, multi-billion dollar industry that acts as in intermediary between those with money (their depositors) and those seeking money (their lendees).
Banking as a business is highly subject to market cycles. The financial crisis of 2008 significantly altered the competitive landscape for commercial banks. New industry rules mandated additional focus of risk control. Financial deregulation also meant that the difference between the largest commercial banks and the smaller, regional banks have become less obvious.
Commercial bank profitability is significantly impacted by fluctuations in interest rates; the demand for bank loans is intrinsically tied to interest rates and economic activity. Following the 2008 financial crisis, federal interest rates have been kept at historically low rates and the economy has been slow to recover. Many banks are trying to lessen their dependency on interest rates by generating more revenue for fee-based services and decreasing their costs.
Trends in the commercial banking industry are largely driven by interest rates and technology. A few of the most significant changes are:
- Increased use of e-commerce practices to streamline the user experience
- “Big data” mining and analytics to provide insight to maximize performance
- Visits to physical bank branches will be of less importance than online banking, but they won’t be replaced altogether
- Increased importance and focus placed on cyber security
Key Performance Metrics
There are no shortage of potential key performance metrics for commercial banks, each more or less appropriate depending on the product and operating area. Some of the simpler ones are:
- Net interest margin (NIM)
- Capital adequacy ratio (CAR)
- Loan-to-deposit ratio (LDR)
- Efficiency ratio
- Non-performing loan ratio
- Loan losses
- Customer profitability
- Revenue per employee
- Growth of loans outstanding
- Growth of deposits
- Non-interest income as a percent of assets
- Customer retention
- Customer penetration
Summary of Valuation Approaches
There are four commonly accepted valuation methods that should be considered when valuing a commercial bank. These methods are:
- Asset-based valuation: This method calculates a business’s equity value as the fair market value of a company’s assets less the fair market value of its liabilities. This approach is also sometimes referred to as a “cost based approach”; that is, the business’s value is equal to the cost of acquiring its physical assets. This approach is seldom used for a commercial bank being valued as a going concern because the value of a retail business is more closely related to its earnings and cash flow.
- Income approach to value (capitalization of earnings): This method is most applicable to companies that face predictable and constant growth in earnings and have a long history of operations. The business value under this method is equal to the cash flow projection for one year divided by a capitalization rate (i.e. the appropriate discount rate less the predicted growth rate).
- Income approach to value (discounted cash flow): The value of equity utilizing this method is equal to the present value of free cash flows available to equity holders over the life of the business. This method works well for both established companies with low growth rates as well as new companies with higher rates of growth, but requires predicting changes in future cash flows.
- Market approach to value: This method utilizes market indications of value based on metrics from guideline publicly traded commercial bank companies and privately held businesses. The financial metrics of public companies or those of private transactions can be used to create valuation multiples that are then used to calculate business value.
Availability of Publically Traded Comparable Companies
For commercial banks that are publicly traded, the availability of financial data makes it possible to compare a subject company to industry benchmarks and apply industry multiples. When valuing a commercial bank, however, it is important to use benchmarks and multiples based on companies that are similar to the subject company.
The top publicly traded U.S. commercial bank companies, ranked by market capitalization, are:
- JPMorgan Chase & Co
- Bank of America Corporation
- Wells Fargo & Company
- Citigroup Inc.
- PNC Financial Services Group, Inc.
- SunTrust Banks, Inc.
- First Republic Bank
- Comerica Incorporated
- Sterling Bancorp
- Home Bancshares, Inc.
- Simmons First National Corporation
- Great Western Bancorp, Inc.
- Renasant Corporation
- State Bank Financial Corporation
- OFG Bancorp
- Opus Bank
- Green Bancorp, Inc.
- Tristate Capital Holdings, Inc.
- Blue Hills Bancorp, Inc.
- People’s Utah Bancorp
- Nicolet Bankshares, Inc.
- Franklin Financial Network, Inc.
- BSB Bancorp, Inc.
- Southern First Bancshares, Inc.
- Provident Bancorp, Inc.
- Unity Bancorp, Inc.
- Sound Financial Bancorp, Inc.
- United Bancshares, Inc.
- Hamilton Bancorp, Inc.
The trailing twelve month price to earnings ratio of these companies range from negative (not meaningful) to 24.9. The trailing price to sales ratios range from 2.08 to 6.13.
Availability of Private Purchase Transactions
In addition to publicly traded commercial banks, data regarding privately held companies can provide a useful benchmark when valuing a business. However, these benchmark market multiples are generally too variable to be useful without further analysis. As with selecting publicly traded guideline companies, care should be given to select private transactions that share similarities with the subject company. The financial metrics of a potential guideline transaction should be compared with those of the subject. Specific factors that are unique for each company must be considered. Additionally, industry economic conditions also vary over time, which can affect commercial banking businesses as investment opportunities.