Financial Services Firms: Governance, Regulations, Valuations, Mergers, and Acquisitions, Third Edition

582 Pages·2011·4.78 MB·English

by  Zabihollah Rezaee(auth.)

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,[phone],fax[phone],orontheWebatwww.copyright.com.
RequeststothePublisherforpermissionshouldbeaddressedtothePermissionsDepartment,
JohnWiley&Sons,Inc.,111RiverStreet,Hoboken,NJ07030,[phone],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